Option backdating is a practice in which a company issues stock options on one date but retroactively changes the date to an earlier time when the market price of the company’s stock was lower. This means the options are “in the money” from the start, and the holder can immediately make a profit.
For example, let’s say a company grants an executive stock options on August 1, when the price is $30 per share. The company then backdates these options to July 1, when the price was only $20 per share. If the executive exercises these options, they can buy shares at the July 1 price of $20, even though the market price on the day of the actual grant was $30.
This practice is considered highly unethical and, in most cases, illegal, because it essentially allows executives to arbitrarily set their own compensation and can deceive shareholders about the true cost to the company of issuing stock options. Option backdating can also lead to violations of tax laws and accounting regulations.
Option backdating was more common in the late 1990s and early 2000s, but several high-profile cases of backdating in the mid-2000s led to increased scrutiny from regulators and the public, and it is now much less common.
Example of Option Backdating
To further illustrate the concept of option backdating, let’s use a fictitious example.
Let’s consider a company, we’ll call it “TechCo”. Now, TechCo’s CEO, John, is due to receive a stock option grant on July 1, 2023. On this date, TechCo’s stock is trading at $100 per share. However, John and the board of directors decide to backdate this option grant to April 1, 2023, when the stock price was only $75 per share.
So, rather than having the option to buy shares at $100 each (which is the actual market price on the date the options were granted), John now has the option to buy shares at $75 each (the retroactively assigned date’s price).
This means John’s options are “in-the-money” by $25 per share right from the start. If he exercises his options, he can immediately buy shares for $75 and sell them for $100, making a profit. This difference can result in significant gains given the usual large number of stock options executives receive.
However, this practice is not only unethical, it’s also generally illegal because it distorts the true financial performance of the company, misleading investors, and potentially violating tax and accounting laws. If discovered, it can lead to significant legal and financial consequences for the company and the individuals involved.
This example is fictitious and simplified to explain the concept. In real-world situations, such schemes often involve complex manipulations of dates and prices and can be hard to detect without thorough financial audits.