On the Benefits of Backdating
32 Pages Posted: 31 Jan 2007
Date Written: January 30, 2007
In this paper we examine options backdating from a wider agency perspective. Recognizing that any options grant will always create timing incentives for managers, we show how the more flexible choice of a grant date implied by backdating actually can mitigate such agency problems. In the absence of backdating, managers can always time investments as to maximize the value of their expected future option grants. While there is no particular wealth-transfer implication of backdating as the wealth consequences are known and can be adjusted for at the time of grant, investment delay however comes at a real economic cost to shareholders. Viewed from an economic perspective, thus, backdating if done right is a shareholder value maximizing feature and thus worth preserving. Explicitly incorporating option pricing theory allows us to quantify managers' incentives. The commonly awarded very long maturity options minimize the sensitivity of the option value to the strike price, and thus minimize moral hazard ahead of an option grant. Our modelling leads to sharp testable implications.
Keywords: backdating, executive compensation, stock options, investment timing
JEL Classification: G30, J33, M52
Suggested Citation: Suggested Citation