Backdating Executive Stock Option Grants: An Agency Problem or Just Efficient Contracting?

60 Pages Posted: 6 Feb 2008 Last revised: 17 Sep 2008

Hamed Mahmudi

University of Oklahoma - Division of Finance

Huasheng Gao

Nanyang Technological University

Date Written: August 2008

Abstract

It is widely documented that managers tend to backdate their stock option grants so that a past date on which the stock price was particularly low is picked to be the grant date. Almost all of the current literature attributes the option backdating behavior exclusively to the agency problem which states that managers manipulate the terms of their option awards at the expense of shareholders. Our paper challenges this idea and demonstrates an alternative explanation for backdating. We show that backdating could be the consequence of efficient contracting that solves executive compensation problems. We first empirically document a rather strong but surprising evidence that better corporate governance is associated with more backdating. We then establish a theoretical model to explain this finding. The model predicts that managerial backdating benefits shareholders by (1) reducing the management compensation cost and (2) increasing managerial incentive. Using a large dataset, we provide strong empirical evidence supporting the model's predictions. Overall, our evidence supports the efficient contracting view of optionbackdating, and contradicts the prevalent agency explanation.

Keywords: Option Timing, Backdating, Executive Compensation

JEL Classification: G32, J33

Suggested Citation

Mahmudi, Hamed and Gao, Huasheng, Backdating Executive Stock Option Grants: An Agency Problem or Just Efficient Contracting? (August 2008). 2008 Western Finance Association Conference Papers. Available at SSRN: https://ssrn.com/abstract=1030907 or http://dx.doi.org/10.2139/ssrn.1030907

Hamed Mahmudi (Contact Author)

University of Oklahoma - Division of Finance ( email )

Norman, OK 73019
United States

Huasheng Gao

Nanyang Technological University ( email )

S3 B2-A28 Nanyang Avenue
Singapore, 639798
Singapore

HOME PAGE: http://www3.ntu.edu.sg/home/hsgao/

Paper statistics

Downloads
493
Rank
45,031
Abstract Views
5,018