Stock option backdating example
Backdating may also violate accounting rules because the stock options, which are equal to extra pay, affect the company's bottom line.By failing to include these options in their books, companies may be overstating their profits – and may, ultimately, have to restate their financials.(Under APB 25, the accounting rule that was in effect until 2005, firms did not have to expense options at all unless they were in-the-money.However, under the new FAS 123R, the expense is based on the fair market value on the grant date, such that even at-the-money options have to be expensed.) Because backdating is typically not reflected properly in earnings, some companies that have recently admitted to backdating of options have restated earnings for past years. The exercise price affects the basis that is used for estimating both the company's compensation expense for tax purposes and any capital gain for the option recipient.Backdating does not violate shareholder-approved option plans.
The lower the strike price, the greater the potential for making money when exercising the options.
However, if the options were effectively in-the-money on the decision date, they might not qualify for such tax deductions.
Unfortunately, these conditions are rarely met, making backdating of grants illegal in most cases.
Company stock option plans are on file with the SEC, with a description of how the strike prices are calculated.
But if the company later provides options at another price without further disclosure, then the company is violating its own plan.Because the option value is higher if the exercise price is lower, executives prefer to be granted options when the stock price is at its lowest.