Option backdating and board interlocks
The increase in the likelihood that a firm begins to backdate stock options that can be explained by having a board member who is interlocked to a previously identified backdating firm is approximately one third of the unconditional probability of backdating in our sample.We use this large sample to explore: the frequency and contractual nature of such awards; whether performance-vesting (p-v) provisions specify meaningful performance hurdles for executives; the magnitude of the incentives to increase value or risk conferred on executives by p-v provisions; the influence the provisions have on accounting and stock-price performance, financial policy, investment policy, and earnings management; and the relation of the propensity to use p-v provisions and the height and form of the vesting hurdle to firm, governance and CEO characteristics.We find strong evidence that board interlocks are related to the spread of backdating.
We focus on the role that director interlocks played in contributing to the spread of backdating since the board of directors has primary authority over the level and structure of executive compensation, including determination of the amount and timing of option grants.
Previously, companies understandably could have thought that questions about backdating were limited to a handful of companies and, thus, no action was required. The new study suggests that the problem is so prolific that it cannot be ignored, particularly in view of the stakes.
If a company discovers a problem it has the opportunity to take control of the situation and expeditiously resolve it.
In addition, we identify several other firm and governance characteristics that are associated with the adoption of option backdating.
Firms with higher stock-price volatility are more likely to start to backdate options, which is consistent with the fact that higher stock-price variation provides more opportunities to backdate options.