Thus, if backdating explains the stock price pattern around option grants, the price pattern should diminish following the new regulation.

Indeed, we found that the stock price pattern is much weaker since the new reporting regulation took effect.

options backdating scorecard-3

Unfortunately, these conditions are rarely met, making backdating of grants illegal in most cases.

(In fact, it can be argued that if these conditions hold, there is little reason to backdating options, because the firm can simply grant in-the-money options instead.)David Yermack of NYU was the first researcher to document some peculiar stock price patterns around ESO grants.

Any remaining pattern is concentrated on the couple of days between the reported grant date and the filing date (when backdating still might work), and for longer periods for the minority of grants that violate the two-day reporting requirements.

We interpret these findings as strong evidence that backdating explains most of the price pattern around ESO grants.

Furthermore, the pre-and post-grant price pattern has intensified over time (see graph below).

By the end of the 1990s, the aggregate price pattern had become so pronounced that I thought there was more to the story than just grants being timed before corporate insiders predicted stock prices to increase.

This made me think about the possibility that some of the grants had been backdated.

I further found that the overall stock market performed worse than what is normal immediately before the grants and better than what is normal immediately after the grants.

In comparison, had the options been granted at the year-end price when the decision to grant to options actually might have been made, the year-end intrinsic value would have been zero.