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Options Backdating Reloaded

options backdating 5 new winnersLooks like the WSJ managed to purchase some more computer time for their options backdating algorithm and in this mornings paper they name the new five lucky winners – click on the graphic to the right.

This issue is of interest to me since I spent over 10 years at Vitesse Semiconductor (VTSS), a company that has been roiled by this issue in the last month. It’s also one of many reasons why incentive options should always be accounted as an expense and included in pro-forma results.

The new article focuses (like the first one did) on how CEO’s used backdating to ensure low strike prices and lock in monetary gains. Without a doubt, this was part of the motivation, but what is overlooked is how CEO’s also use options as compensation for employees.

The cost of options, particularly those inflated due to backdating, were transparent to financial statements until new accounting rules were enacted. Bonuses and salaries show right up on the income statement. Leaders of these companies weren’t backdating options just to enrich themselves, but also to improve perceived financial performance by moving the compensation structure off the financial statements. Employees flush with backdated in-the-money options required less ordinary compensation and R&D/SG&A could be reduced.

Solid options expense accounting would have removed the incentive for most companies to even consider the practice.

Another observation – it is entirely possible that some options were not backdated, and that companies used their inside knowledge to select the price when they knew subsequent gains were likely. While this is still not illegal, such practices would be disincentivized by rigorous options accounting.

KLA Options BackdatingFinally, It would be good for the WSJ to open source their algorithm and database, so that the public can see a ranked list of companies and boards can take the appropriate steps. In the perfect world, every Board of Directors would have taken a cursory glance at a chart (like the one for KLA) and taken appropirate action before learning about it on page A1 of the WSJ. How is it possible with such a trend that the board itself was not suspicious?

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