Guilty Until Proven Innocent: The Economic Consequences of the Initiation and the Outcome of Internal Investigations of Option Backdating

Abstract

Backdating occurs when a company retroactively changes option grant dates to dates when its stock was trading at a relatively low price. Firm announcements of backdating have lead to adverse publicity from the media and negative pronouncements from academics regarding the economic effects and motivation of those involved. This research finds that backdating signals to the capital markets that these firms have ineffective governance systems and poor internal controls. Further, nearly half of the backdating investigations show no backdating has occurred or that it was unintentional. This indicates negative media attention and unwarranted impact on share prices, in many cases.

Keywords: Backdating, Employee Stock Options, Corporate Governance, Internal Control

JEL Classification: M41, G34