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How can backdating be a good thing?

Commentator Robert Reich

TEXT OF COMMENTARY

TESS VIGELAND: More than 60 companies have disclosed investigations into whether they've backdated executive stock options to coincide with days when their stock prices were low. Forty grand juries are involved in the probes. The corporate scandal du jour has sparked a raft of shareholder lawsuits, and at least 17 people have quit or been fired in connection with the investigations. Now comes word the Securities and Exchange Commission plans to take action. Commentator Robert Reich advises not to hold our breath.


ROBERT REICH: Christopher Cox, chairman of the SEC, says the agency is poised to bring the first option-backdating case. But it's unclear exactly what the SEC will find to be illegal.

Cox says forging documents and lying to corporate directors and shareholders about option grants could be the basis of criminal as well as civil charges.

But Cox's fellow SEC Commissioner, Paul Atkins, argued in a recent speech that companies who manipulate the timing of their executive options may not even be guilty of violating securities laws.

According to Atkins' logic, timing an award of options so they can be exercised just before the company issues a positive quarterly earnings report that raises share values does create a windfall for executives.

But precisely because of this windfall, companies are able to compensate their executives more cheaply. They can issue fewer stock options or provide lower salaries. So by timing stock options this way, argues Atkins, companies end up saving money, and investors pocket the savings.

Well extending this logic, Atkins' argument would make backdating completely legal. Backdating creates a huge executive windfall, which means companies can get by with even lower executive compensation costs.

But Atkins' logic is it completely ignores the purpose of executive stock options in the first place. They're supposed better align executive incentives with the interests of investors, inducing executives to work harder to raise share prices.

Yet stock options have this effect only if executives don't know what their option will be worth in the future.

If they can go back in time and pick a date when the share price was especially low relative to what it is now or will surely be when a positive quarterly earnings report is issued, the incentive disappears because the future is no longer the future. It's the past.

If the incentive that's supposed to be in a stock option disappears, shareholders are worse off. More stock has been issued, which dilutes the value of their own shares. And they get nothing in return.

Anyone who believes companies will reduce executive compensation by the inflated value of a stock option has not been paying much attention to what's happened to executive compensation in recent years.

So will SEC follow Commissioner Atkins' illogic? I don't know, but when I find out, I'm going to back date my answer to make it sound like I knew all along.

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