Corporate governance and backdating of executive stock options

A study by Erik Lie of the University of Iowa and Randall Heron at Indiana University (see "Does Backdating Explain the Stock Price Pattern Around Executive Stock Option Grants?," Journal of Financial Economics, February 2007) formed the basis of a Pulitzer Prize-winning series of investigative articles by the Wall Street Journal in 2006.Internal investigations may be initiated by a company's board of a directors through a special committee. Accountants, auditors, investors, and analysts alike should understand the history of backdating, the risks companies under investigation face, how to search for indicators of backdating, and how these scandals might ultimately affect businesses and shareholders. Options backdating is the practice of using hindsight to choose a beneficial calendar date in the past for purposes of granting a stock option to an employee, officer, or director of a company.

Some companies have as many as four separate ongoing investigations: one each by the SEC and DOJ, and one each undertaken by management and the board of directors.Just when it seemed safe to close the book on the scandals of the pre-Sarbanes-Oxley, pre-Internet bubble era, the stock options backdating fiasco that came to light in 2006 is a reminder that the history of the period is still being written.While the legality of stock options backdating will ultimately be decided case by case in the courts, dozens of companies are currently under investigation.The Center for Financial Research and Analysis (CFRA) performed a survey of the 100 companies with the greatest (as a percentage of revenues) pro forma options compensation in the pre-SOX period.Of those 100 companies, 17 had, on three or more occasions, option grant dates that were at or near 40-day stock price lows which were immediately followed by a significant stock increase.

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