The impact of the options backdating scandal on shareholders

(For more insight, see Although it may appear shady, public companies can typically issue and price stock option grants as they see fit, but this will all depend on the terms and conditions of their stock option granting program.

However, when granting options, the details of the grant must be disclosed, meaning that a company must clearly inform the investment community of the date that the option was granted and the exercise price. In addition, the company must also properly account for the expense of the options grant in their financials.

That is, they grant their executives stock options with an exercise price (or price at which the employee can purchase the common stock at a later date) equivalent to the market price at the time of the option grant.

They also fully disclose this compensation to investors, and deduct the cost of issuing the options from their earnings as they are required to do under the Sarbanes-Oxley Act of 2002.

Cases of backdating employee stock options have drawn public and media attention.

According to a study by Erik Lie, a finance professor at the University of Iowa, more than 2,000 companies used options backdating in some form to reward their senior executives between 19.

Beyond Sarbanes-Oxley, the SEC approved changes to the listing standards of the NYSE and the Nasdaq in 2003 that require shareholder approval for compensation plans.

But, there are also some companies out there that have bent the rules by both hiding the backdating from investors, and also failing to book the grant(s) as an expense against earnings.

On the surface - at least compared to some of the other shenanigans executives have been accused of in the past - the options backdating scandal seems relatively innocuous.

In the worst cases of options backdating abuse, the stock exchange on which the offending company's stock trades and/or regulatory bodies such as the Securities and Exchange Commission (SEC) or National Association of Securities Dealers can levy substantial fines against the company for perpetrating fraud.

(For more information, see The executives of companies involved in backdating scandals may also face a host of other penalties from a range of governmental bodies.

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