Stock options allow employees to purchase a particular number of common shares of company stock at a specified price over a specified time period. Tying the option price to the market price benefited both the issuing company and the employee at the grant date: The company did not have to record any compensation expense for accounting purposes upon issuance; the employee did not receive a taxable benefit upon issuance and needed to pay taxes only when the exercised options were sold in the future.
Essentially, stock options were designed to reward current performance with a future benefit when executives neither needed nor desired additional current cash.
Because stock options could be cashed in and the shares subsequently sold, there always existed a motivation for executives with options to quickly boost the stock price, through fair means or foul. As some recent corporate scandals show, foul often meant manipulating financial statements to increase net income and, concurrently, stock prices.
Back dating stock options ethics and morality other words, it "Back dating stock options ethics and morality" possible for executives to engineer opportunities for their stock options to rise in value. When stock prices rise above a given option price, the expectation is that the managers who received such options will exercise them and become larger shareholders in the corporation.
Such holdings should motivate executives to have a greater interest in making the entity ever more profitable, because personal and corporate performance objectives are aligned.
The bull market of the s brought substantial value to stock options, but when the market began a downturn, investor value dropped substantially.
In other words, executive-owners continued to benefit from huge pay packages while investor-owners suffered from the downturn in the value of their stock portfolios. One solution that some companies adopted was to reprice previously granted stock options to a price below the current market price.
In this technique, the company cancels the underwater options and replaces them with new options six months and one day later; the new options are set at the then-current market price. This variable accounting treatment would create a negative income statement impact equal to the number of repriced shares multiplied by the difference between the original option price and the year-end market price; the treatment would continue for each year until the options were exercised, forfeited, or cancelled.
The executive benefits from the reduction in option price, but the Back dating stock options ethics and morality and the other non—stock-option-holding investors face a lowered net income, which, in turn, could generate a lower share price.
Repricings effectively reward executives for corporate difficulties, rather than hold them accountable. In addition, if the company has to acquire treasury stock in the future to satisfy option holders upon exercise, the market activity could create an even higher price and greater gains to the exercising employee.
Such gains would benefit all stockholders but could make potential new investors less able to acquire the higher-priced stock.
If options for high-level executives were repriced while those of lower-level employees were not or were not repriced to the same degreeone might view such discriminatory treatment as unethical, given that the executives should be held responsible for the downturn in earnings that presumably precipitated the downturn in stock price. Boards of directors have defended the repricing of executive stock options by stating that it helps retain executives who are essential to company performance.
The authors believe that the issue that must be addressed in the face of this logic is how essential such executives actually are if they were the people in charge during the market decline. There is some evidence that the performance and retention rationales behind repricing are flawed.
Daily and Dan R. Dalton and Catherine M. As discussed earlier, when stock options are issued, the strike price is typically set to equal the market price at the option date to avoid recording compensation expense and the incurring taxable income to the recipient.
The companies involved range from the low-tech to the high-tech, from the start-up to the well-established. Some companies came forth voluntarily; some were subpoenaed.
Many are conducting their own internal investigations. It seems that the practice of backdating has been prevalent but hidden for quite a while.
Prior toa company was not required to report its issuance of stock options until after the close of the fiscal year, providing ample time to backdate options. Section of the Sarbanes-Oxley Act SOX tightened the reporting requirements for the issuance of executive stock options; companies now must report options on Form 4 within two days of their issuance.
This requirement should significantly reduce the opportunity for backdating, if companies comply with the new regulation. One would hope that such delays have been resolved since that study was conducted. Such a tactic could be seen as an extra reward to the executive, who obtains cash even if the stock prices fall from the bad publicity resulting from backdating: It is obvious to the authors that the law did, in fact, prompt many companies to use stock options as a form of noncash compensation, but to infer that this justifies the backdating of options seems a huge leap of logic.
Whether all cash compensation of CEOs should be tax deductible is an issue that should be addressed on its independent merits, or lack thereof, with a clear eye toward acknowledging the massive discrepancy that exists between worker pay and executive compensation in the United States. According to a BusinessWeek survey of large U.
Inequality and the Roots of Economic InsecurityFebruary ; www. In addition, companies are now facing potentially massive restatements that could reduce reported income, which would likely trigger further downturns in stock value.
Shareholder and pension-fund lawsuits have been launched against some companies and are on the horizon for others. Because the SOX disclosure requirements make it essentially impossible to backdate stock options, some companies have turned to two other tactics to increase executive pay: Spring-loading refers to the practice of issuing options shortly before announcing good news to investors; bullet-dodging refers to delaying an option grant until after bad news has been reported.
Atkins believes that opportune timing of options grants merely provides the best benefit to the grantee at the least cost to the corporation.
Technically, the timing of options grants does not fall under Regulation FD; however, a case could be made that the end results are similar: Someone or some group benefits to the exclusion of others. In the case of selective disclosures, certain analysts and Back dating stock options ethics and morality clients benefit; in the case of option timing, certain inside executives benefit.
Using Indexing to Determine Option Price. Many people might argue that backdating and repricing have occurred because companies thought it was unfair to penalize executives for recent downturns in stock prices that were due to macroeconomic pressures and industry fluctuations beyond the control of CEOs. While backdating and repricing present questionable behaviors by corporate committees, an alternative methodology—indexing stock options—might be viewed as more fair and effective in rewarding the highest-performing executives.
In such a process, the board of directors would select a group of companies, such as industry rivals, to serve as a benchmarking peer group. The option-issuing company indexes or ties the exercise price to the benchmark group.
In theory, economic and industry factors should affect similar Back dating stock options ethics and morality in similar fashion.
Many other companies voted on adopting the use of indexed options inbut few of those measures were approved. Despite the inherent fairness in the indexing concept, many major U. On the positive side, indexing would eliminate the situation in which CEOs are granted millions of dollars of options in a rapidly rising stock market when the companies led by those CEOs performed worse than competitors.
Indexing would also stop the practice of repricing stock options. Such perspectives can serve as the basis for asking important questions when compensation packages are being awarded.
It was noted above that repricing options differently for different groups of grantees may be viewed as unethical. Using virtue ethics to gauge this tactic, the authors examined both the action and the reasons for taking a particular action as follows: The justice theory of ethics requires equals to be treated the same way but allows unequals to be treated differently; executives could be viewed as equals and all others could be viewed as unequals.
As such, differential repricing between the two groups would be considered ethical and appropriate. The international business community, in the form of the OECD and ICGN, provides no indication that executives should be viewed any differently from other shareholders. Assessing options repricing and backdating from an ethical theory of rights perspective requires determining who is entitled or has the right to what.
Investors and creditors who have provided funds to an organization have the right to receive accurate, reliable, and transparent financial statements. Options backdating and repricing either ignore or do not consider that right of those investors and creditors, and, as such, these techniques would be seen as unethical.
Engaging in options backdating and repricing as a corporate employee, or an external auditor, with knowledge that such actions have taken place, would be unethical from a professional perspective. Options backdating and repricing can also be viewed from a utilitarian perspective.
The decision of whether Back dating stock options ethics and morality actions are ethical would be made by weighing the benefits to management as individuals and the perceived benefits to the company and its shareholders via increases in share price against the costs of the action and the long-term negative effects on investors and creditors of false and misleading financial information. The Kantian theory of ethics named for the 18th-century German ethicist Immanuel Kant directs one to act only as if the action were to become universal law.
From this perspective, if stock option backdating and repricing were intended to manipulate or deceive any stakeholders, then the action would be Back dating stock options ethics and morality a lie and could not be justified by Kantian ethics; the ends do not justify the means.