I've been writing for sometime about my skepticism concerning the backdating so-called scandal. The posts are collected in my executive compensation archive.
My basic line is that backdating was not in fact the blatant theft from
the shareholders it has been portrayed as. There are reasonable
explanations, and it's not clear the shareholders suffered any harm
(though the plaintiffs' lawyers who jumped on the backdating bandwagon
are regretting their investments). There may have been disclosure violations, but those don't make for the scandal of the century.
The latest theory and evidence along these lines Mahmudi and Gao, Backdating Executive Stock Option Grants: An Agency Problem or Just Optimal Contracting? The paper shows
that
backdating could be the consequence of optimal contracting when
shareholders are maximizing their value. We first establish a
theoretical model which predicts that managerial backdating benefits
shareholders by (1) reducing the management compensation cost and (2)
increasing managerial incentive. Using a large dataset, we provide
strong empirical evidence supporting the model's predictions. Providing
further support for our theory, we document evidence that strong
corporate governance reinforces backdating. Overall, our evidence
supports the optimal-contracting view of option backdating, and
contradicts the prevalent agency explanation.
The
compensation cost thesis is based on the idea that risk-averse,
under-diversified CEOs want a strike price lower than the grant-date
stock price. Thus, the authors say, backdating yields "lower
compensation cost for a given level of managerial incentive."
Indeed, the data show that
backdating
is negatively related with the CEO’s total annual compensation and his
cash compensation. This evidence suggests that shareholders
simultaneously grant less cash payment to CEOs when allowing them to
backdate their option grants. What is more important, the total
compensation cost is actually reduced in the presence of option
backdating, which is contradictory to the view that backdating makes
shareholders overpay. This evidence strongly supports our
optimal-contracting explanation that backdating saves compensation cost
for shareholders.
With respect to
incentives, the authors show "a strong positive association between
backdating and the pay-performance relation in executive pay."
And the authors "document robust evidence that strong
governance is associated with more backdating. This result directly
supports our optimal-contracting explanation and goes against the
prevailing agency argument."
Finally, the authors give the standard tax/accounting
explanation for why backdating rather than in the money options. So,
yes, backdating was an end run around accounting rules that effectively
penalized in the money vs other options, but the rules made little
sense. This doesn't make manipulation of the rules right, but it's a
far more benign explanation than the one that launched myriad costly
investigations, lawsuits and prosecutions.