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On the surface - at least compared to some of the other shenanigans executives have been accused of in the past - the options backdating scandal seems relatively innocuous.
But ultimately, it can prove to be quite costly to shareholders.
Clearly, for those who own shares in companies that don't play by the rules, options backdating poses serious risks.
If the company is punished for its actions, its value is likely to drop substantially, putting a major dent in shareholders' portfolios.
They also fully disclose this compensation to investors, and deduct the cost of issuing the options from their earnings as they are required to do under the Sarbanes-Oxley Act of 2002.
But, there are also some companies out there that have bent the rules by both hiding the backdating from investors, and also failing to book the grant(s) as an expense against earnings.
The Bottom Line Although more culprits in the options backdating scandal are likely to emerge, because standards such as Sarbanes-Oxley have been instituted, the assumption is that it will be more difficult for public companies and/or their executives to hide the details of equity compensation plans in the future.
This means they must wait for the stock to appreciate before making any money.A Real-Life Example A perfect example of what can happen to companies that don't play by the rules can be found in a review of Brocade Communications.The well-known data storage company allegedly manipulated its stock options grants to ensure profits for its senior executives and then failed to inform investors, or to account for the options expense(s) properly.(To learn more, read .) In short, it is this failure to disclose - rather than the backdating process itself - that is the crux of the options backdating scandal. To be clear, the majority of public companies handle their employee stock options programs in the traditional manner.That is, they grant their executives stock options with an exercise price (or price at which the employee can purchase the common stock at a later date) equivalent to the market price at the time of the option grant.
If the company sets the prices of the options grant well below the market price, they will instantaneously generate an expense, which counts against income.