Thursday, October 12, 2006

What's the hype about this backdating option scandals?

We've seen a lot of these in the recent past, including big names like Apple, McAfee and BCGI.
So what's the deal here? What exactly is the scandal?

Options (referred as ESOs - Employee Stock Options) are typically designed to give recipients a stake in improving the company's share price by allowing them to purchase shares in the future at their price on the day the option was granted. By backdating grants to earlier days when the stock price was particularly low, recipients can get extra profit. So, for example, if my company gives me an option to buy stock at $20, when it is trading today at $25, the strike price would be $20 and market price would be $25, and my profit when I excersise the option would be $5.

So, it seems ok, right, this backdating? It was, when companies were just required to state details about option grants to management and employees, in their 10K notes or report. But recently in 2005, GAAP has mandated under the new FAS 123R, that all companies expense out (on their Income Statement) all options, even at-the-money options. So, in an attempt to boost their earnings (with lesser expenses), companies have started backdating their option grants to executives to a much lower strike price, so that they will have to expense out lesser. That's the scandal, becuase such artificial boosting of net income is absolutely not acceptable to shareholders!!

There has been at least 28 dismissals, suspensions and resignations of corporate officials amid probes of stock-option practices at their companies. More than 100 companies are facing scrutiny from federal regulators and prosecutors, who are focusing on the practice of improperly backdating options to make them more valuable to recipients. Yeah!

Refer to this page (it's a pretty cool one) if you want to understand backdating further...



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