Stock option grants are meant to align the incentives of executives with those of the shareholders.
The research showed that many executives were granted options immediately before large gains on the stock price. Lie made the observation that the sharp increase in stock price after option grant dates was indicative of option backdating.
To eliminate the possibility of coincidence, a single executive's grant dates were analyzed.
Through this analysis, the backdating of options is shown to be unethical, leading to the question of what should be done about it.
Recommendations are presented addressing the major weaknesses in backdating prevention.
Before the creation of the Sarbanes-Oxley Act of 2002, a company did not have to report stock option grants until 45 days after the end of the fiscal year they were granted (ISS, 2006).
This lengthy window of opportunity allowed many executives to reset their grant dates to coincide with days where the stock was trading at its lowest.A failure to increase the firm's value essentially makes the options worthless. One, filed on June 22 on behalf of the Alaska Electrical Fund, alleges ACS' "entire Board of Directors and certain top officers" are guilty of "violations of federal and state law, including breaches of fiduciary duty, abuse of control, constructive fraud, corporate waste, unjust enrichment and gross mismanagement which have caused damage to ACS." The 59-page complaint alleges that all the defendants named in the suit--which is pretty much everyone at the top of the ACS food chain, including Rich's replacement Lynn Blodgett, who was not named in the April lawsuit--"participated in the concealment of the backdating option scheme" or knew of it and did nothing to stop it.The cases of Affiliated Computer Services Inc., which is being investigated by the Department of Justice and the Securities and Exchange Commission for backdating stocks--that is, giving stock options to its top execs and dating them just before those stocks experienced a sharp increase in value, thereby allowing the likes of former CEO Jeffrey Rich, Chairman Darwin Deason and many others to make easy millions. Citing several Wall Street JournalÂ pieces on the backdating scandal, the suit also claims that ACS is guilty of insider trading, since its filings with the SEC were "false and misleading," at least till the SEC showed up to express a keen interest in the matter.However, this change in tax law only placed a cap on executive salary and not on performance-based forms of compensation.Stock option grants come in the form of call options, which allows the owner of the option to buy the firm's stock at some given time in the future for a set price.While backdating stock options is not illegal, the improper disclosure of information in financial statements is.