CHAPTER 8

U.S. STOCK OPTION BACKDATING SCANDALS

Anthony Tarantino, PhD

8.1 INTRODUCTION

8.2 THE PROS AND CONS OF STOCK OPTIONS

8.3 THE AMERICAN SCANDALS

8.4 WHY STOCK OPTIONS SHOULD BE AVOIDED

8.5 SUGGESTIONS IN MANAGING OPTIONS FOR THOSE WHO MUST RETAIN THEM

8.6 HOW THE UNITED STATES GOT INTO SUCH A MESS

NOTES

8.1 INTRODUCTION

In all employer-employee relationships, there exists a classical dilemma in how to align the interests of both parties. This is sometimes known as the principal-agent problem and explained in detail in Professor Vinod Hrishikesh's "Fraud and Corruption" chapter (Chapter 9). The traditional means to align these two interests include wages, profit sharing, bonuses, and commissions. The goal is to tie the employee's compensation to the employer's well-being. Although they have been around for over half a century, stock options have become a popular vehicle only in the past decade as a great means to align the two interests, to preserve a company's cash, and promote long-term employee loyalties. Stock options have been promoted over the past 20 years as a reform to what was viewed as excessive executive compensation. Unfortunately, in practice stock options have not always been implemented as designed. The major scandals unfolding in the United States involve the backdating of option grant dates to the point most favorable to the recipient—defeating the purpose of tying compensation to performance.

Over 200 U.S. companies have conducted internal reviews of the ...

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