Backdating option grants
This pioneering study was published in the Journal of Finance in 1997, and is definitely worth reading.
(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.A 2004 NY Times article describes this case in greater detail (the article is available here), and so does a 2006 article in Tax Notes Magazine (available here).In a 2004 CNBC interview, Remy Welling said that "this particular -- well, it's called a 30-day look-back plan, is even widespread in Silicon Valley and maybe throughout the country."The terms "spring loading" and "bullet dodging" refer to the practices of timing option grants to take place before expected good news or after expected bad news, respectively. This is what Professor Yermack hypothesized in his article discussed above, though he never used these terms.For several years, Micrel allowed its employees to choose the lowest price for the stock within 30 days of receiving the options.After these stock option terms came to the attention of the IRS in 2002, it worked out a secret deal with Micrel that would allow Micrel to escape million in taxes and required the IRS to keep quiet about the option terms.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.Thus, if backdating explains the stock price pattern around option grants, the price pattern should diminish following the new regulation.Indeed, we found that the stock price pattern is much weaker since the new reporting regulation took effect.ESOs are usually granted at-the-money, i.e., the exercise price of the options is set to equal the market price of the underlying stock on the grant date.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.