Options backdating law

Theoretical and empirical work suggests that directors suffer reputation penalties in the director labor market for poor monitoring. Fried in their book —is that there is little or no accountability for excessive or abusive pay practices.

However, it is unclear whether these penalties extend to poor monitoring of executive pay. However, no study has empirically examined this question.

Part of the reason is the difficulty of defining and identifying “poor monitoring” with respect to executive pay.

In most cases, pay levels and structures can be justified on economic grounds (e.g.

Most shareholder approved option plans prohibit in-the-money option grants (and thus, backdating to create in-the-money grants) by requiring that option exercise prices must be no less than the fair market value of the stock on the date when the grant decision is made. For example, because backdating is used to choose a grant date with a lower price than on the actual decision date, the options are effectively in-the-money on the decision date, and the reported earnings should be reduced for the fiscal year of the grant.

(Under APB 25, the accounting rule that was in effect until 2005, firms did not have to expense options at all unless they were in-the-money.

The SEC’s Enforcement Division and the offices of the United States Attorney are investigating the option granting practices of dozens of companies and actions taken by their executives.The government investigations are being separately pursued by the U. Securities and Exchange Commission (SEC) and the U. Department of Justice and it appears likely more companies will be targeted.In addition to the governmental investigations, numerous civil suits have been filed against companies and their officers and directors, alleging breach of fiduciary duty, and several senior executives have already been terminated or forced to resign due to their roles in option grant practices.The issues raised by these numerous investigations include tax, accounting, securities law disclosure, corporate governance and insurance issues.Key implications include: Accounting Issues: Prior to certain recently adopted rules, if an option was granted with an exercise price at or above the market price at the date of grant, the company was not required to recognize that grant as an expense.

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