[UPDATE:Â In order to avoid linking glitches we removed the quotes from around the phrase, "all about norms" in the original title.Â This post thus has a different url than the original but is otherwise the same.]
In a post titled, â€œBackdating: Yes, Virginia, Execs Do Want Inflated Pay,â€? over at PrawfsBlawg, Matt Bodie weighs in on the backdating â€œscandal.â€? As many of you know, the topic has been much-discussed of late here at TOTM and over at Larry Ribsteinâ€™s Ideoblog (who, it turns out, beat us to this punch), and youâ€™re probably wondering when weâ€™re ever going to stop. Well, we (Geoff and Josh) think Mattâ€™s post is so misguided that it merits its own paragraph-by-paragraph rebuttal in this, TOTMâ€™s first-ever co-authored blog post!
Matt begins by quoting both me and Josh (you mean, me and Geoff) on why backdating isnâ€™t the worrisome bother the Wall Street Journal, Gretchen Morgenstern, and Matt Bodie make it out to be. Then he takes us to task:
I think Geoff and Josh are putting together two notions here: (1) the value of the grants is published at some point down the road, and (2) even if the accounting was a little unusual, it doesn’t really matter because executives could and would have paid themselves the same amount in any event. Although I’m doubtful about (1), it’s really (2) that I’d like to take issue with here. Yes, I do believe that in the absence of backdating, executive compensation would have been lower.
First, it is not our claim that â€œthe value of the grants is published at some point down the road.â€? Our claim is that the value of the grants is known â€“ as well as (or even better than) it can be for any options â€“ the moment the grants are made (or, assuming minimal insider trading, the moment the grants are disclosed), just as it would be for non-backdated options. Not only is the value known, but it is incorporated into share price (the effects of expected dilution when the options are exercised).
This is key. Most critics of backdating seem to act as if the options were in fact granted on the backdated date and not disclosed until later. In reality, disclosure is made in due course; only the strike price is set with reference to an earlier dayâ€™s stock price. There is not, in fact, delayed disclosure.
Matt goes on:
As for (1), companies may have reported the value of the options down the road, and they may have reported the strike price. But as Jeff Lipshaw discussed here, accounting rules required different reporting for options issued at a price lower than the current market price for the stock. So backdated options were clearly a lie: they said they were issued on a date when they were not actually issued. In addition, it may have been a violation of the company’s stock option plan to issue options at a price other than the market price of the date in question. Backdated options would thus also violate the requirements of such plans.
As Lipshaw notes in that very post, the economic effect of options is independent of their accounting treatment. The fetishization of accounting is something Geoff has taken on elsewhere. But it bears repeating: Accounting is a convenient and imperfect means of quantifying behavior. It does not purport to — nor does it — represent true economic values. Itâ€™s a short cut; itâ€™s a little like looking for your keys under the street light even though you lost them elsewhere. It certainly makes some calculations and some inter-firm comparisons easier. But accounting cannot do the impossible. There remain countless ways that, even under the same standards (hell, even under the same rules), accounting measures vary from firm to firm. If one firm expenses backdated options and another doesnâ€™t, aside from the possible technical rule violation, the effect on inter-firm comparison, share price, market valuation, etc. is unlikely to be significantly impaired.
The point is that, even if the accounting treatment of backdated options is different than the treatment of options that are not backdated but nevertheless are granted “in the money” on the date of grant (the issue addressed in the Lipshaw post), youâ€™d have to believe in a woefully imperfect an inefficient market to believe that the actual economic effect would pass unnoticed.Â And, as Larry points out, even if it did, it takes a heroic and wholly-unsupported assumption to assert that the consequence of the oversight would beÂ to line executives’ pockets.
As we have said here and elsewhere: THERE IS NO LIE. Here, in fact, is Geoffâ€™s comment to the Lipshaw post referenced by Matt:
Iâ€™m not sure why anyone thinks options backdating is a lie (technical violation of a rule, maybe, but lie, no). There’s just no harm in the practice. Itâ€™s not like the options cruise along for a period of time out of the money (and priced by the market accordingly) and then are miraculously turned into at the money or in the money options the moment they are exercised. Rather, the day the options are issued, they are issued with a strike price AS IF they had been issued on an earlier date when the market price was lower. But thereâ€™s no lie here â€“ itâ€™s just a convenient way of providing more compensation (which I think is part of Jenkins’ point. Once again, he seems to be reading Truth on the Market (see my comments to this post). The same could be done, I assume, by arbitrarily picking a strike price lower than the market price on the day of issuance. Either way, as I note in the comment liked above, the moment the at the money options are issued they pull down share price. They are not free, nor is their effect somehow hidden from investors. So why should there be any moral outrage or any serious consequences here at all?
There is more (much more) below the fold.Â Continue Reading…