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BACKDATED OPTIONS: A GOOD THING?
June 22, 2006
The Wall Street Journal law blog calls my attention to a piece by WSJ columnist Holman Jenkins ($link) criticizing the coverage of the option backdating scandal. The blog entry says:
Jenkins writes that anyone “who waded through the literature on CEO compensation has long been aware of studies showing that executives reap non-random gains on their stock options.” He continues: “No surprise here: Options are meant to motivate executives to produce non-random gains, and the whole theory of corporate governance is that executives are self-interested and possess inside information, so you’d expect them to negotiate pay deals for themselves from which they’d benefit.”
Mr. Jenkins goes on:
Yet there is nothing categorically corrupt or improper about backdating to justify a conclusion that the boards here weren’t doing just that.
The scandal element, instead, arises because ever-shifting accounting, regulatory and tax standards were, by some readings, punitive during the years in question toward choosing a past date to make an options package effective.
That's cool: "by some readings" tax standards were "punitive." In fact, by any but the most willfully obtuse reading, backdated stock options are disqualified from the the exemption options otherwise enjoy from the $1 million tax deduction limit on executive compensation. By backdating options the executives have cost their companies, and their shareholders, millions of dollars in additional taxes. That by itself is a scandal. Even if you don't think that tax law is good policy - and I don't - that doesn't excuse executives who transfer millions of dollars of shareholder money to the IRS by flouting it.
UPDATE: In the comments IRS whistleblower Remy Welling notes the no-backdating rule for incentive stock options; that is independent of the $1 million compensation cap.
ANOTHER UPDATE: A more sympathetic view of the Jenkins piece from the barren icy wastes of southern Canada.
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Comments
If the options are incentive stock options, then according to IRC Section 422(b)(4), to qualify as Incentive Stock Options, they must be equal to or greater than the Fair Market Value on the date of grant.
Well, the date of grant would be the date that the 30 day period began. It is not the date within the 30 day period, looking back, that the options were the lowest price during that 30 day period.
Also, this is similar to the APB 25 accounting rule which says that if the option price is less than the FMV on the date of grant, the company must show that difference as an expense for GAAP.
A public company is required to disclose its Options Plan to the SEC.
This is not a pricing methodology for a public company, either, simply because public companies per the Treasury Regulations for IRC Sec 422 are required to use the over-the-counter price - that is, NASDAQ or NYSE.
Posted by: Remy Welling | June 22, 2006 9:41 AM