The companies involved in the recent scandal were backdating options to a time when the stock price was lower, making them immediately lucrative. stock options by claiming that they’re an incentive for performance: the executives get rich only if they do a good job and the stock goes up.As it happens, companies are perfectly free to issue options priced below the current market: those are called “in the money” options, and they’re worth something right when they’re issued. But there’s a rule that companies have to follow when they issue “in the money” options: they have to disclose it in their financial statements. Unless executives can time-travel, though, it’s hard to make that case for backdated options.However, companies must report their option grants within two days of their issue and list all stock options as expenses.
Backdating allowed companies to reward employees with in-the-money options while getting the favorable accounting treatment of at-the-money options. Classifying the options properly would have lowered the number in the “earnings” box, and so C. O.s assumed that it would also drag down the company’s stock price.
It’s fraud when options are backdated without telling shareholders or when companies change documents such as board meeting minutes or board approvals to support the backdating.
Companies have historically granted stock options “at the money,” meaning the exercise price is equal to the stock’s fair market value on the grant date.
For instance, if the board meeting is on January 3, 2020, and Company XYZ stock closes at per share that day, then the exercise price of Jane's 2020 stock option grant is per share.
That is, she has the right, but not the obligation, to purchase 1,000 shares of Company XYZ stock for per share.