The Wall Street Journal (see discussion of article below) pointed out a CEO option grant dated October 1998.
The number of shares subject to option was 250,000 and the exercise price was (the trough in the stock price graph below.) Given a year-end price of , the intrinsic value of the options at the end of the year was (-) x 250,000 = ,750,000.
Backdating allows executives to choose a past date when the market price was particularly low, thereby inflating the value of the options.
An example illustrates the potential benefit of backdating to the recipient.
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.
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.
Backdating does not violate shareholder-approved option plans.
announced Thursday that it has agreed to settle all of the class actions and derivative suits brought by its shareholders last year alleging the company deceived investors by backdating stock options, and otherwise manipulating its accounts.“We are very pleased to reach a settlement with the plaintiffs in these actions,” said Vitesse CEO Christopher Gardner in a press release.According to the SEC, from September 2001 through April 2006, the defendants “engaged in an elaborate channel stuffing scheme in order to improperly record revenue on product shipments.” As a result, Vitesse inflated the revenue it reported in its financial statements for 14 quarters, the SEC alleged in a complaint filed in U. District Court for the Southern District of New York.The defendants also “engaged in a scheme to backdate stock option grant dates for their personal benefit and the benefit of other Vitesse executives and employees,” the SEC alleged.As the options were priced below the stock's fair market value when they were actually awarded, this created instant paper gains to the executives.This instant paper gain was equivalent to extra compensation and was thus a cost to Vitesse.CIV 240483, California Superior Court, Ventura County.