Stock Option Backdating

STOCK OPTION BACKDATING

Over the past decade CEO compensation has increased by 212 percent while the average factory worker has seen his or her wages rise by less that 50 percent . Top wage earners for 2006 include Merrill Lynch, CEO Stanley O'Neal, who received 46 million dollars in compensation and Lloyd Blankfein, CEO of Goldman Sachs, who earned over 53 million in total compensation . Most CEO packages include some compensation in the form of stock options, which can be perplexing, by giving the misapprehension that the potential handout is performance related; when, in fact, the compensation is guaranteed. The recent scandal involving the use of backdated stock options, to compensate CEO's, is the latest example of corporate greed and deceit. CEO's and their board members appear to be looking out for themselves, at the expense of their employees, and shareholders.

Stock options became an increasingly important part of CEO compensation packages beginning in the 1990's. The stock market was taking off, and stock options were the currency of choice because companies did not have to expense them. Incentive plans at that time incorporated such metrics as profitability and the company's stock price. The theory is that paying for performance aligns the interests of the person running the company with those of the shareholders. Companies typically justify options by claiming they are an incentive for future performance: the executive gets rewarded for doing a good job in raising the company's stock price. However, unless executives can time-travel, you cannot make that case for backdated options. The only reason it is done is to lavish more money on executives without having to disclose it to shareholders.

Stock options, which are granted to an employee of a corporation, allow that employee to purchase company stock at a specified price (referred to as the "exercise price") for a specified period of time; stock options are funded by "shareholder dollars". When the employee exercises the option, he or she purchases stock from the company at the excise price, regardless of the stock's price at the time the option is exercised. If the stock price is lower than it should be, the employee pays less and the company gets less when the stock option is exercised. Many companies make their stock option grants at the same time each year. This policy eliminates the potential for surreptitious backdating; these options are known as, "at the money options".

Most of the companies currently under investigation have no such safeguards in their employment agreements with their top executives. Rather, they contain either, "floating dates" or simply allow the CEO's to pick the date for the option to be granted. By permitting this "back dating" of stock options, it becomes an entitlement and no longer an incentive for performance.

Through backdating, a company awards or grants an employee the option of buying shares of stocks, millions of shares in some cases. What makes this practice suspect, is allowing the employee to pick the date of the grant, with the benefit of 20/20 hindsight. For example, if the company stock sold a few months ago at $6 share, but now is worth $60 as share. The employee exercises his option to buy the company stock now, but "back dates" the purchase to the earlier price of $6. There is no risk and he makes a profit of $54 per share immediately; regardless of how he, or the stock had recently performed.

There is nothing inherently illegal about either paying large compensation or even backdating an option contract, so long as proper corporate procedures were followed and the grant does not amount to a waste of corporate assets. Where public corporations