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Study Links Options Backdating to Corporate Governance Weaknesses

Study Links Options Backdating to Corporate Governance Weaknesses

by Toby Lucich on January 14, 2007

Back in 2004, many companies were arguing against a Financial Standards Accounting Board (FASB) mandating stock option expensing (or reporting the estimated value of outstanding options, since the exact value is not determined until options are exercised.) In February of that year, University of Iowa Professor Erik Lie submitted his now-celebrated that broke open the options backdating (for which 120 companies have by now come under scrutiny) upon its May 2005 publication in Management Science. Talk about duplicity–many companies claimed the value of options is too difficult to calculate with precision (and so their value should not be reported at all) while executives were busy calculating when to retroactively exercise options to reap windfalls stolen from shareowner value.

The idea of manipulating stock option timing was first introduced in a 1997 Professor David Yermack. A few papers followed, with researchers scratching their heads over how executives could possibly predict the fortuitous stock movements reflected in the statistical anomalies of exercise timing documented in their research, until Prof. Lie surmised the unthinkable. Perhaps these fortunate executives were not predicting the future but rather tracking the past–a supposition Prof. Yermack had trouble believing at first because the “whole idea was so sinister,” even in the post-Enron world when executive fraud was exposed as widespread.

Study Links Options Backdating to Corporate Governance Weaknesses

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