Stock option backdating definition
/What is Stock Option Backdating?
Stock option backdating involves setting the issuance date of options prior to their actual issuance date. By doing so, the strike price of each option can be set lower for the option recipient, allowing more room for the person to earn a profit when the options are eventually exercised. Backdating is considered unethical but is difficult to spot, since it is not immediately obvious in a company’s financial statements.
Understanding Stock Option Backdating
Stock options give their holder the right to purchase the common stock of a corporation at a specific price. This right is available over a date range, such as for the next five years. Once a stock option is used to buy shares, these shares are typically sold right away, in order to pay any related income taxes. Consequently, a person who has been awarded stock options will only use them if the current market price is higher than the exercise price built into the options. The exercise price is usually the market price of the shares on the date when the options were awarded. For example, a person is awarded 1,000 stock options that allow him to buy the shares of the employer for $10.00 per share. After three years have passed, the price of the shares has increased to $12.00. The investor exercises the options to buy 1,000 shares from his employer for $10,000. He immediately sells the shares on the open market for $12,000, pocketing a profit of $2,000.
Backdating occurs when the date at which the option price is set is shifted backward to that date on which the market price of the stock was the lowest. By doing so, those awarded stock options can now buy the shares at a lower exercise price, so that they reap larger profits when they sell the shares. To use a variation on the preceding example, management backdates the stock options by three weeks, to a day on which the company’s stock price was $9.00 per share. The person awarded the options later buys the shares at $9.00 and sells them for $12,000, resulting in a profit of $3,000. Because of the backdating, the individual earned a 50% larger profit than would otherwise have been the case.
Related AccountingTools Courses
How to Detect Stock Option Backdating
There are two ways to detect stock option backdating. They are as follows:
Review board minutes. Examine the date of the board of directors minutes to see when the options were authorized, and then trace this date back to when the options documentation was completed. A disparity between the dates indicates that backdating has occurred.
Compare market prices to grant dates. If stock option grant dates are routinely occurring at or near the low point of a stock’s market price, there is a good chance that the date was set deliberately to coincide with the low stock price. If so, further investigation should be conducted to see if the grant date coincides with the Board’s grant date.