This practice requires at least a nominal investment on the part of the option holder if he or she wishes to exercise.
The CEO’s conflict of interest between short-term personal wealth maximization and long-term shareholder interests tends to tilt in the shareholders’ favor.
If the exercise price were $0, then options would be nothing more than free stock grants, and treated as such in the eyes of recipients.
But the great majority of public companies issue options with an exercise price equal to the market price at the date of grant.
Simply put, backdating a stock option grant amounts to ripping off shareholders by shortchanging the company treasury.
Shares are issued to option holders at artificially low prices and the company gets an artificially low amount of capital in return for its shares.
The SEC and other federal authorities are currently investigating more than 50 companies suspected of illegal, undisclosed options backdating practices, and the first criminal charges relating to these practices are expected shortly.
The practice of backdating options is not illegal as long as it is disclosed to shareholders.
Stock options are promoted by their supporters as the most effective way to align executive and employee interests with those of shareholders.
They are supposed to transform executives from fly-by-night plunderers in the mold of former Tyco or World Com executives into rational leaders who make prudent, long-term-oriented decisions with shareholder capital.
But are options really as great for all parties as many have assumed?