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Eso backdating

In essence, the revision enabled companies to increase executive compensation without informing their shareholders if the compensation was in the form of stock options contracts that would only become valuable if the underlying stock price were to increase at a later time.

(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.

Traditionally, stock option plans have been used as a way for companies to reward top management and "key" employees and link their interests with those of the company and other shareholders.

The act of options backdating has become much more difficult as companies are now required to report the granting of options to the SEC within two business days.

This adjustment to the filing window came in with the Sarbanes-Oxley legislation.

The authors would like to thank Erik Lie, Svein-Arne Persson, and Wei Xiong for comments and discussions.

Options backdating is the practice of altering the date a stock option was granted, to a usually earlier (but sometimes later) date at which the underlying stock price was lower.

Corporations, however, have defended the practice of stock option backdating with their legal right to issue options that are already in the money as they see fit, as well as the frequent occurrence in which a lengthy approval process is required.

In 1972, a new revision (APB 25) in accounting rules resulted in the ability of any company to avoid having to report executive incomes as an expense to their shareholders if the income resulted from an issuance of “at the money” stock options.

The number of shares subject to option was 250,000 and the exercise price was $30 (the trough in the stock price graph below.) Given a year-end price of $85, the intrinsic value of the options at the end of the year was ($85-$30) x 250,000 = $13,750,000.

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.

This process occurred when companies were only required to report the issuance of stock options to the SEC within two months of the grant date.