Forward dating stock options

The practice of “backdating” stock option grants has recently captured the of a lower stock price to allowing executives to select a grant date during a problems and review their option granting procedures going forward.
Table of contents

• Option Period Vs Fixed Date Forward Contracts: Explained
• Options backdating
• Backdating Employee Stock Options: Tax Implications
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Compensation deduction limitations under IRC section m , nonqualified stock options, incentive stock options, and the new penalties under IRC section A are discussed below. The authors conclude with the latest wrinkles arising from stock options, backdated exercise dates, and forward-dated grant dates. Accounting and Legal Implications. One loophole of section m is that the limitation does not apply to performance-based compensation.

Stock option plans are generally designed to be performance-based to escape the section m limitation.

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Four criteria must be met to establish compensation as performance-based: Three additional conditions are required for stock options and stock appreciation rights to qualify as performance-based compensation: Violating any of these conditions would cause the stock options to be considered non—performance-based compensation and, thus, IRC section m limitations would apply.

Backdating grant dates violates the first three conditions because the necessary documentation and approvals were not complete. Backdating would violate the last condition above for options issued in-the-money. To the extent that backdated stock options were erroneously included as a deductible performance-based compensation expense, corporate taxable income may be significantly underreported.

The IRC section m limitation was established in to discourage excessive executive compensation. Since , the portion of executive compensation attributable to stock options has increased dramatically. Not surprisingly, many attribute the popularity of stock options to the passage of section m.

Changes in the tax law may not be the entire reason, however. In , FASB backed off on a proposal to require stock option disclosures. And in , FASB was forced to rescind a decision that would have required all stock options to be expensed after Congress threatened to take over financial standards-setting if FASB required the expensing of stock options. The continuing favorable accounting treatment may have also contributed to the growth in stock options. Stock option plans can generally be classified into two categories: NSO grants are generally nontaxable events.

Upon exercise, an employee recognizes ordinary income for the difference between the stock value and the exercise price. This income is employment compensation, which requires income and FICA tax withholding.

No corporate tax consequences exist when employees dispose of stock acquired from NSOs. Perversely, and purely from a tax perspective, backdating increases corporate deductions and the benefits that may be available as compared to the deductions available at the actual grant date.

Nejat Seyhun; The Dating Game: We provide evidence of two variants of a dating game that entails picking a grant date ex post , that is, after the board's compensation decision is made: Consistent with back-dating, we find stock return behavior around the grant date to be positively related to reporting lag. In the promptly reported sample, we find stock return behavior and the pattern of reporting lags consistent with forward-dating.

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5. Backdating of Executive Stock Options.
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Our calculations show that managers can obtain economically significant benefits by playing the dating game. Most users should sign in with their email address. If you originally registered with a username please use that to sign in. To purchase short term access, please sign in to your Oxford Academic account above. Don't already have an Oxford Academic account? An example illustrates the potential benefit of backdating to the recipient.

In comparison, had the options been granted at the year-end price when the decision to grant to options actually might have been made, the year-end intrinsic value would have been zero. Is backdating of ESO grants illegal? Backdating of ESO grants is not necessarily illegal if the following conditions hold: No documents have been forged. Backdating is clearly communicated to the company's shareholders.

After all, it is the shareholders who effectively pay the inflated compensation that typically results from backdating ESOs. Backdating does not violate shareholder-approved option plans. Backdating is properly reflected in earnings.

For example, because backdating is used to choose a grant date with a lower price than on the actual decision date, the options are effectively in-the-money on the decision date, and the reported earnings should be reduced for the fiscal year of the grant. Under APB 25, the accounting rule that was in effect until , firms did not have to expense options at all unless they were in-the-money.

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However, under the new FAS R, 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.

Backdating is properly reflected in taxes.



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. Thus, an artificially low exercise price might alter the tax payments for both the company and the option recipient. 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. In fact, it can be argued that if these conditions hold, there is little reason to backdating options, because the firm can simply grant in-the-money options instead.

What is OPTIONS BACKDATING? What does OPTIONS BACKDATING mean? OPTIONS BACKDATING meaning

How do we know that backdating takes place in practice? In particular, he found that stock prices tend to increase shortly after the grants. He attributed most of this pattern to grant timing, whereby executives would be granted options before predicted price increases. This pioneering study was published in the Journal of Finance in , and is definitely worth reading.

In a study that I started in and disseminated in the first half of and that was published in Management Science in May available at http: Furthermore, the pre-and post-grant price pattern has intensified over time see graph below. By the end of the s, the aggregate price pattern had become so pronounced that I thought there was more to the story than just grants being timed before corporate insiders predicted stock prices to increase.

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This made me think about the possibility that some of the grants had been backdated. I further found that the overall stock market performed worse than what is normal immediately before the grants and better than what is normal immediately after the grants. Unless corporate insiders can predict short-term movements in the stock market, my results provided further evidence in support of the backdating explanation.

In a second study forthcoming in the Journal of Financial Economics available at http: The graph below shows the dramatic effect of this new requirement on the lag between the grant and filing dates. To the extent that companies comply with this new regulation, backdating should be greatly curbed.