Updating Backdating

Today’s Wall Street Journal points an accusatory finger at new batch of companies who awarded top executives stock option grants dated just ahead of a sharp rise in the company's share price. Dealbreaker is happy to bring you the highlights.

First off, the following companies are the subject of today’s story: KLA-Tencor Corp., a leading semiconductor-equipment maker, Boston Communications Group Inc., a prepaid-wireless-technology provider, Renal Care Group Inc., a dialysis service company, chipmaker Trident Microsystems Inc, and telescope maker Meade Instruments Corp. Also mentioned in the article is aircraft interior manufacturer B/E Aerospace Inc., whose CEO reseigned from the board of Brooks Automation after options backdating there came to light.

Second, an answer to the question: what the big deal with backdating?

Here’s how the WSJ explains it:

Under accounting rules that were long in effect until recently, issuing a below-market option should trigger extra compensation expense, reducing a company's net income. Companies that failed to record that expense may have to restate their financial results, in some cases going back many years. Backdating also could run afoul of complex tax laws, requiring companies and individual to pay back taxes and penalties.

In short, it seems that companies may have granted options that were already in the money following a run-up in the stock price, and then stamped an earlier date on the grant in order to avoiding reporting an additional compensation expense in their financials.

Another objection to backdating is that the practice seems to undermine some the incentive value of options. Many see options as a way of tying the compensation of executives to the performance of the company's stock in the future. Back-dated options would reward executives for past-performance, letting them take advantage of a rise in share price that has already occurred. It doesn't, however, totally erase the incentive value since the executives would still stand to benefit from a further rise in the stock.

[A quick note. The "post-hoc" objection to backdating may be over-rated. Pardon us for getting a bit nerdy here, but the possibility of receiving backdated options may itself provide the type of incentive structure many see as a justification of options to begin with. That is, if CEO Ken expects that if he succeeds in driving up the companies share price he will be granted an option backdated to the earlier, lower price, he certainly has a strong incentive to work toward that higher price. In fact, he may have more of an incentive than he would if he had to wait for the compensation committee to meet and grant him a new round of options at the later, higher strike price.]

Five More Companies Show Questionable Options Pattern [WSJ]