Study Finds Backdated Options-Corporate Governance Link

November 21, 2006 ( - A new academic study of instances of stock options backdating between 1996 and 2005 has found a correlation between the backdating practices and corporate governance weaknesses.

The study, Lucky CEOs, found that “grant date manipulation resulted in an abnormal fraction of the grants being given on days where the stock price was at the lowest level of the month,” – what the authors labeled “lucky grants.”

According to the study report:

  • The backdating practice was correlated with  factors that are associated with increased influence of the CEO on the company’s internal pay-setting and decision making process.
  • Lucky grants were more likely to occur when the company did not have a majority of independent directors.
  • Lucky grants were more likely to occur when the CEO had longer tenure. The contribution of increased tenure to a higher likelihood of getting a lucky grant was especially significant for CEOs hired from outside.
  • The backdating practice involved CEOs who benefited from lucky grants who also received a significantly higher total compensation from other sources, not a lower one.

Study authors Lucian Bebchuk, Yaniv Grinstein, and Urs Peyer concluded: “These findings are consistent with the view that grant date manipulation reflects governance problems.”

The study found that compared to a random assignment, a day was most likely to be chosen as the grant date for a stock option if the stock price was at its lowest level for the month on that day. The day was second-most likely to be chosen if its price was the second-lowest for the month, and third-most likely to be chosen if its price was the third-lowest for the month, according to the study.

Among other things, the report concluded “backdated grants were not provided as a substitute for other forms of compensation but rather conferred extra benefits on executives already receiving higher pay relative to their peers.”

Of the lucky grants that were discovered, an estimated 1,150, or about half, “owe their status to opportunistic timing rather than mere luck,” the study said. Altogether, more than 10% (850) of all CEOs and 12% (720) of all firms received or provided lucky grants produced by opportunistic timing.

The average gain to CEOs from grants that were backdated to the lowest price of the month was estimated to exceed 20% of the reported value of the grant and to increase the CEO’s total reported annual compensation by more than 10%.

About 43% (1,000) of all lucky grants were “super lucky,” defined as grants awarded at the lowest price of the calendar quarter, the researchers reported. Sixty-two percent of the super-lucky grants were estimated to be the result of grant manipulation.

“In contrast to impressions produced by cases coming under scrutiny thus far, grant manipulation has been widespread across old economy firms and [was] not concentrated in new economy firms. A majority of the manipulated lucky as well as super-lucky grants were awarded by old economy firms,” the study report said.

According to Lucky CEOs, over time, a given CEO was more likely to receive a lucky grant when the payoffs from such a lucky grant were higher. The universe of grants studied by the authors included all the at-the-money, unscheduled grants awarded to public companies’ chief executive officers during the relevant decade.

The study report is here .