Backdating Executive Option Grants - Nanyang Technological ...

More documents

Recommendations

Info

As described in the Appendix, by December 31, 2012, 25 out of the 260 cases (9.6%) arestill under investigation, 183 cases (70.4%) are settled with firms restating their option expensebut without explicit punitive actions taken to the executives, 24 and 52 cases (20%) are settledwith firms restating their option expense and explicit punitive actions taken to the executives. 25Among these 52 cases, all the executives investigated paid some penalties, in 46 cases executivesare fired, in 26 cases executives are also banned from being public firm officers/directors for upto five years, and in 6 cases executives are put in jail. 26Although the ex post penalty onexecutives inferred from the 52 cases above is severe, Heron and Lie (2009) estimate that 13.6%of all option grants to top executives during the period 1996–2005 were backdated and 29.2% offirms manipulated grants to top executives at some point between 1996 and 2005. Given howwide spread backdating was, the number of firms that experienced some sort of legalconsequence seem to be very small (i.e., the ex ante probability of being caught and penalizedseems small). 274.4. Empirical ImplicationThe efficient contracting view thus does provide an explanation that predicts a positiverelationship between governance and backdating. This evidence alone though is far from24 This number is only growing. For example, in the recent case of Broadcom all criminal charges againstBroadcom’s co-founders Henry Samueli and Henry T. Nicholas III, and also the company's former chief financialofficer (CFO) William J. Ruehle were dismissed by U.S. District Judge Cormac J. Carney (See Jenkins 2009). Thisanecdotal evidence indicates that the legal system has also started to treat backdating charges with more caution,highlighted in the not-guilty verdict of Broadcom’s executives.25 We only account for the explicit punitive actions because we can clearly attribute them to the backdating cases.However, it is possible that the firms punish their executives in an implicit way (such as not renewing contracts andnot giving them directorship after retirement).26 These punitive actions are not mutually exclusive and some executives may be subject to more than one type ofpunishments.27 The settlements from many backdating suits are confidential, and it is possible the public does not even know thatthere has been a suit/settlement. Thus, the reported number of backdating investigations may be smaller than thenumber in reality. (We thank the anonymous referee for providing this comment.)27
convincing as we set out to find a theory to explain this fact. Luckily, there are auxiliary testsflowing from this theory that differentiate between the managerial power and the efficientcontracting perspectives. We turn our attention to these now.As advanced in the theory, a certain in-the-money option is optimal because it caneffectively reduce the cost posted on risk-averse and under-diversified managers. Given that theeffect of risk-aversion and under-diversification is usually more evident in riskier firms, loweringstrike price via backdating is therefore more vital for executives in those companies. This view isalso consistent with the empirical result in Column (1) of Table 5, which highlights thesignificantly negative coefficient of G-index×ReturnStd. This coefficient suggests that bettergovernedfirms backdate more in response to high stock return volatility.Under-diversification is one of the driving forces behind the optimality of granting in-themoneyoptions. The benefit of backdating options will be higher for more under-diversifiedCEOs. Although the degree of diversification in the CEO’s portfolio is not directly observable inthe data, longer-tenure CEOs are more likely to be poorly diversified. This could be due to thehigh level of human capital and firm-specific wealth locked within the manager’s firm. Theabove argument is consistent with the empirical results in Column (3) of Table 5, in which theterm G-index×Tenure displays a significantly negative coefficient. This coefficient implies thatbetter-governed companies backdate more when their CEOs have longer tenure.If backdating can reduce compensation cost for shareholders, then this saving will be moresizeable for larger CEO grant size. Supporting this view, the empirical result in Column (4) ofTable 5 shows a negative coefficient for G-index×GrantSize, indicating that better-governedfirms backdate more for larger option grants.If backdating reduces shareholders’ cost for compensating the CEO, it can also lower costs for28
Page 1 and 2: Backdating Executive Stock Option G
Page 3 and 4: ackdating for some measures of gove
Page 5 and 6: pay by retroactively timing their o
Page 7 and 8: movement surrounding the option gra
Page 9 and 10: Responsibility Research Center (IRR
Page 11 and 12: Hartzell and Starks (2003), we firs
Page 13 and 14: grants, 6,513 unique firm-year obse
Page 15 and 16: Figure 2 displays the average cumul
Page 17 and 18: deviation decrease in G-index is as
Page 19 and 20: strengthens this relation. Heron an
Page 21 and 22: expense of compensating them for be
Page 23 and 24: where∂V∂Pis the CEO incentive,
Page 25 and 26: a fixed exercise price. 16Thus, the
Page 27: that most other firms are backdatin
Page 31 and 32: predictions generated directly from
Page 33 and 34: Column (2) shows that backdating is
Page 35 and 36: In the presence of backdating, the
Page 37 and 38: leads firms that backdated to incre
Page 39 and 40: destroys firm value ex post when it
Page 41 and 42: ReferencesAboody, D., and R. Kaszni
Page 43 and 44: Harris, M., and A. Raviv, 2008, A t
Page 45 and 46: Table 1. Overview of the CEO Stock
Page 47 and 48: Table 3. Backdating and Corporate G
Page 49 and 50: Table 5. The Interaction Effects be
Page 51 and 52: Table 7. Explanations of Backdating
Page 53 and 54: Table 9. Backdating and Level of CE
Page 55 and 56: Table 11. Backdating and CEO Pay Ch
Page 57 and 58: Mean returns5.0%3.0%1.0%-1.0%A-50 -
Page 59: $1,200,000$1,000,000Incentive $5000

Backdating Executive Option Grants - Nanyang Technological ...

You also want an ePaper? Increase the reach of your titles

Delete template?

Save as template?