Stock option backdating Essay Example | Topics and Well Written Essays - 1500 words

Stock option backdating - Essay Example Backdating can take on several meanings. The most culpable form of backdating involves "intentionally changing the date used to set an option's exercise price to one on which the stock's price was at a low" (Ellsworth et al., 2006). This form of backdating was abetted by the relatively lax legislation before the Sarbanes-Oxley Act was enacted in 2002. The Sarbanese-Oxley Act mandated that stock options be filed within 2 days after they are granted (FindLaw, 2002), mitigating the backdating problem. Before the Sarbanese-Oxley Act came into effect, option grants were reported using Form 5 which primary use is for the disclosure of "the transactions and holdings of directors, officers, and beneficial owners of registered companies" (Securities and Exchange Commission, n.d.). Furthermore, the form is required to be filed only "on or before the 45th day after the end of the issuer's fiscal year" (Securities and Exchange Commission, n.d.). This essentially means that if the stock options w ere granted early in the fiscal year, investors would not come to know of them until almost 1 year later, giving more leeway for insiders to manipulate the date on which the exercise price was established. Most of the 63 companies involved in stock option backdating "relate to a roughly six-year period prior to the Sarbanes-Oxley legislation" (Grant and Nuttall, 2006). ... Such company actions and policies include sloppy documentation, delays in the grant approval process, and the wrong interpretation of APB Opinion No. 25 Accounting for Stock Issued to Employees (Ellsworth et al., 2006). Summary of Statement No. 123 Accounting for Stock Issued to Employees prescribes that the intrinsic value or fair value based method of accounting be used for the valuation of stock options (Financial Accounting Standards Board, 1995). Most companies continue with the intrinsic value based method of accounting (Ellsworth et al., 2006). Under the intrinsic value based method, "compensation cost is the excess, if any, of the quoted market price of the stock at grant date or other measurement date over the amount an employee must pay to acquire the stock" (Financial Accounting Standards Board, 1995). If company actions are efficient, the measurement date would be the same as the grant date, and no compensation cost is recorded. More often than not, due to procedures such as the signing of the resolution by the directors, the measurement date would be at a later date than the grant date. If the price of the underlying stock has risen over the period between the measurement date and the grant date, the stock option is in the money and the difference should be recognized as compensation expense. Backdating occurs when companies, whether intentionally or unintentionally, choose to use the price of the underlying stock on the grant date as the basis for measuring the compensation cost. An example of the above form of backdating of stock options is Michaels Stores Inc., which understated compensation expenses by as much as $60 million between 1990 and 2001 (Bulkeley, 2006; Maremont, 2006). Michaels