Taxes And Stock Option Backdating
Stock option backdating has been covered in many periodicals but the Harvard Law Blog does a pretty good job of analyzing the causes and motivations behind this practice. If there are any readers particularly interested in shorting stocks and or analyzing corporate governance, this paper is for you.
Article Introduction (Via Harvard Law Blog)
We investigate the opportunistic timing of stock option exercises by insiders. We focus on a group of exercises where there likely exists both the incentive and the ability to backdate an option exercise: exercises paid in cash where the insider holds the acquired shares. Once the decision to exercise is made, insiders who plan to hold the acquired shares have an unambiguous personal tax-based incentive to exercise on the day with the lowest possible stock price. Unlike exercises in which the acquired shares are sold immediately through a broker, these exercise-and-hold transactions are often accomplished in-house. Thus, we expect that opportunistic backdating, to the extent it exists, is more likely to occur in exercise-and-hold transactions. We find that exercise-and-hold transactions tend to occur at monthly stock price lows. Before SOX, we find that 13.55% of exercise-and-hold transactions by CEOs occurred on the day the stock was at its lowest price during the month (i.e. suspect exercises). After SOX, only 7.20% of CEO exercise-and-hold transactions occurred on that day.
Article Excerpts (Via Harvard Law Blog)
“Consistent with the prediction that backdating an exercise-and-hold transaction is driven by personal tax considerations, we find that the likelihood of a suspect exercise is increasing in the potential taxes saved by the option holder from exercising on the day of the month with the lowest closing price before SOX, but not after SOX.”
“We estimate that our sample of CEOs saved an average of $96 thousand in taxes per exercise by exercising on the day of the month with the lowest closing stock price.”
“Together with the remainder of this study, our analysis provides additional evidence on the magnitude and determinants of opportunistic behavior associated with executive stock options.”