Tag: Backdating


Corporate Governance and Blockchains

David Yermack is Professor of Finance at the NYU Stern School of Business. This post is based on a recent article authored by Professor Yermack.

In the paper, Corporate Governance and Blockchains, which was recently made publicly available on SSRN, I explore the corporate governance implications of blockchain database technology. Blockchains have captured the attention of the financial world in 2015, and they offer a new way of creating, exchanging, and tracking the ownership of financial assets on a peer-to-peer basis. Major stock exchanges are exploring the use of blockchains to register equity issued by corporations. Blockchains can also hold debt securities and financial derivatives, which can be executed autonomously as “smart contracts.” These innovations have the potential to change corporate governance as much as any event since the 1933 and 1934 securities acts in the United States.

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Opportunism as a Managerial Trait

David Hirshleifer is Professor of Finance at the University of California, Irvine. This post is based on an article authored by Professor Hirshleifer and Usman Ali, Portfolio Manager at MIG Capital. Related research from the Program on Corporate Governance includes Insider Trading via the Corporation by Jesse Fried (discussed on the Forum here.)

In trading their firms’ stocks, insiders must balance the profits of informed trading before news, the scrutiny by regulators that such trading can engender, formal policy restrictions by firms of insider trading activities, and diversification and liquidity motivations for selling shares after vesting of equity-based compensation. This mixture of motivations and constraints makes it is hard to decipher the information content of insider trades, especially because different trades may be intended to exploit news arriving at short or long horizons. This noise makes it feasible, up to a point, to conceal deliberate opportunism from regulators such as the SEC.

Empirically, there are some indications that insiders do exploit private information. Past research finds that insider purchases positively predict subsequent abnormal returns. On the other hand, effects are much harder to identify for insider sales, presumably because such sales are often performed for non-informational reasons, such as to reduce risk or to consume.

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Suspect CEOs, Unethical Culture, and Corporate Misbehavior

The following post comes to us from Lee Biggerstaff of the Department of Finance at Miami University, David Cicero of the Department of Finance at the University of Alabama, and Andy Puckett of the Department of Finance at the University of Tennessee.

Trust is part of the foundation of public markets. Scandals at firms such as Enron and HealthSouth fractured this foundation and motivated market participants to ask why executives and other employees at these firms misled investors. Some regulators and experts conjecture that the roots of these scandals can be traced to the actions and attitudes of those at the very top of corporate leadership. In the words of Linda Chatman Thomsen (Director, Division of Enforcement, Securities and Exchange Commission) “Corporate character matters—and employees take their cues from the top. In our experience, the character of the CEO and other top officers is generally reflected in the character of the entire company.” In our paper, Suspect CEOs, Unethical Culture, and Corporate Misbehavior, forthcoming in the Journal of Financial Economics, we provide evidence consistent with this perspective by demonstrating an empirical link between CEOs’ revealed character and the misbehaviors of the firms they manage.

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Executive Gatekeepers: Useful and Divertible Governance?

The following post comes to us from Adair Morse of the Finance Group at the University of California, Berkeley; and Wei Wang and Serena Wu, both of Queen’s School of Business, Canada.

In our paper, Executive Gatekeepers: Useful and Divertible Governance?, which was recently made publicly available on SSRN, we study the role of executive gatekeepers in preventing governance failures, and the counter-incentive effects created by equity compensation. Specifically, we examine the following two questions. First, do executive gatekeepers actually improve governance in the average firm? Second, does the effectiveness of gatekeepers in ensuring compliance and/or reducing corporate misconduct depend on their incentive contracts?

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Executive Turnover Following Option Backdating Allegations

The following post comes to us from Ed Swanson, Professor and Durst Chair at the Mays Business School at Texas A&M University; Jap Efendi of the Department of Accounting at The University of Texas at Arlington; Rebecca Files of the Naveen Jindal School of Management at The University of Texas at Dallas; and Bo Ouyang of Penn State Great Valley.

In the paper, Executive Turnover Following Option Backdating Allegations, forthcoming in The Accounting Review, we investigate how the Board of Directors and the managerial labor market (two private-sector monitoring mechanisms) respond to an allegation of option backdating. Allegations have been directed at numerous well-known public companies, including Microsoft, Apple, Home Depot, Costco, and United Health. Backdating occurs when executives designate as the grant date a day earlier than the one on which the board actually made the decision to grant options. Managers typically select an earlier date when the market price was lower, so they receive options that are already “in-the-money” on the actual grant date.

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Rich-Hunt: The Speech

Editor’s Note: The following post comes to us from Roger Donway, program director of the Atlas Society’s Business Rights Center. This post is based on an edited version of Mr. Donway’s remarks at the Atlas Society’s 2012 summer conference, available here.

My monograph Rich-Hunt is subtitled “The Backdated Options Frenzy and the Ordeal of Greg Reyes.” But if you have not read the monograph, and if you missed the whole frenzy of 2005–2011, you may well wonder: What is a backdated option? Indeed, you may not even be quite sure about what an option is and how it works. So, let me start there.

An option is a type of security that gives a person the right to buy a share of a company’s stock at a specified price. For example, an option might give you the right to buy a share of Google at $5. That would be a very valuable option. Or an option might give you the right to buy a share of Google at $5,000. That would not be so valuable.

Typically, when a company gives options to its employees as a form of compensation, the employees are allowed to buy shares in the company (which is called “exercising the options”), and the price at which they may buy the stock is called the option’s “exercise price,” or “strike price.” Typically, however, they can exercise their options only after a defined span of time (called “the vesting period”) and before a certain date (called “the expiration date”).

So, the value of such option grants rests entirely on the possibility that the stock will be selling above the strike price during the period of time that the employee is permitted to use the option to buy a share. If the stock price is higher than the exercise price, the employee can reap a profit by purchasing a share of stock at the exercise price and then immediately selling that share on the stock market. Of course, if the stock price does not rise above the strike price between the time that the options vest and the time that they expire, then the options are forever worthless.

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Reputation Penalties for Option Backdating and the Role of Proxy Advisors

Fabrizio Ferri is an Assistant Professor of Accounting at Columbia University. Work from the Program on Corporate Governance about executive compensation includes the book Pay without Performance and the article Paying for Long-Term Performance, both by Bebchuk and Fried.

In the paper Reputation Penalties for Poor Monitoring of Executive Pay: Evidence from Option Backdating, forthcoming at the Journal of Financial Economics, my co-authors (Yonca Ertimur of Duke University and David Maber of the University of Southern California) and I examine whether directors are held accountable for poor monitoring of executive compensation.

Theoretical and empirical work suggests that outside directors incur reputation penalties in the director labor market for poor monitoring. However, it is unclear whether these penalties extend to poor monitoring of executive pay. A widely held view—articulated by Prof. Bebchuk and Prof. Fried in their book Pay without Performance—is that there is little or no accountability for excessive or abusive pay practices. Yet no study has empirically examined this question. Part of the reason is the difficulty of defining and identifying “poor monitoring” with respect to executive pay. In most cases, pay levels and structures can be justified on economic grounds (e.g. retention, incentives, attraction of talent) and with reference to the behavior of peer firms. Unless these practices are perceived as clearly “outrageous,” it is unlikely that directors will be concerned about reputation costs. Opacity in pay disclosures makes it even more difficult to assess the quality of pay practices.

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Mechanisms of Board Turnover: Evidence from Backdating

The following post comes to us from Frederick Bereskin of the Department of Finance at the University of Delaware and Clifford Smith, Professor of Finance and Economics at the University of Rochester.

In our paper, Mechanisms of Board Turnover: Evidence from Backdating, which was recently made publicly available on SSRN, we examine a set of events that involve observable corporate misdeeds: stock option backdating. These misdeeds were generally revealed within a narrow window of time, required the complicity of the board, and in many cases directors benefited directly through backdated grants. Examining board turnover associated with stock option backdating thus enables us to gain more insight about the mechanisms by which directors depart their boards. Although information that would allow us to identify each of these five steps is not publicly available, events that are typically available include the following: (1) whether a director resigns, (2) whether a director appears on the proxy as nominated for reelection, and (3) whether a director is reelected. Additionally, there are press releases that sometimes accompany these decisions, but these announcements must be interpreted with care. For example, when a director does not appear on the proxy, the board and/or nominating committee might have chosen not to renominate the individual for reelection or the director might have declined to stand for reelection (an event that is frequently disclosed, especially if driven by a director retirement policy). However, a director who will not be renominated often is permitted to announce that he or she has chosen to resign or not to seek reelection.

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Should Size Matter When Regulating Firms?

The following post comes to us from Deniz Anginer, Financial Economist in the Development Research Group at the World Bank; M. P. Narayanan, Professor of Finance at the University of Michigan; Cindy Schipani, Professor of Business Law at the University of Michigan; and H. Nejat Seyhun, Professor of Finance at the University of Michigan.

In our paper, Should Size Matter When Regulating Firms? Implications from Backdating of Executive Options [15 N.Y.U. J. Legis. & Pub. Pol’y (forthcoming Winter 2011)], we present a data point relevant to significant issues of policy concerning areas of law where small firms have either been granted exemption from regulations or not investigated for violations of laws that, on their face, apply to them. Whether small firms should be exempted is an empirical question the answer to which depends on the likelihood of such firms violating regulations.

There are numerous instances in the law where small firms have been granted exemptions from regulatory restrictions. The major justification offered by the proponents for this exemption of small firms is the claim that regulation has a disproportionate effect on these companies. For example, in the area of securities law, regulation of small firms has drawn criticism throughout the years. It has been lamented that “the [Securities Exchange Commission] SEC [has] never . . . understood small businesses, their capital needs, their importance to our economy, and the special circumstance they face…” Similarly, since its enactment in 2002, the Sarbanes-Oxley legislation (SOX) has been highly criticized for the level of expense it has imposed upon firms’ efforts to comply with the legislation. In order to decide if regulation should be lenient towards small firms, we need to first understand what types of firms are likely to be engaged in illicit activity. If we knew that small firms are also likely to violate laws, as a matter of public policy, should we continue to exempt firms from regulatory scrutiny solely due to size? That is, should size matter in regulatory policy decisions? Furthermore, should size be a factor when prosecutors target firms for investigation?

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Lucky CEOs and Lucky Directors

Lucian Bebchuk is a Professor of Law, Economics, and Finance at Harvard Law School. Yaniv Grinstein is an Associate Professor of Finance at the Johnson Graduate School of Management at Cornell University. Urs Peyer is an Associate Professor of Finance at INSEAD.

The December issue of the Journal of Finance features our article Lucky CEOs and Lucky Directors. This study integrates two discussion papers we circulated earlier, Lucky CEOs, and Lucky Directors.

Our study contributes to understanding the corporate governance determinants and implications of backdating practices during the decade of 1996-2005. Overall, our analysis provides support for the view that backdating practices reflect governance breakdowns and raise governance concerns. (For recent expressions of the opposite view that backdating did not reflect governance breakdowns, see the recent op-ed by WSJ columnist Holman Jenkins, who argues that backdating was a “meaningless accounting violation.”)

In particular, we find that:

  • (i) Opportunistic timing has been correlated with factors associated with greater influence of the CEO on corporate decision-making, such as lack of a majority of independent directors, a long-serving CEO, or a lack of a block-holder with a “skin in the game” on the compensation committee;
  • (ii) Grants to independent directors have also been opportunistically timed and that this timing was not merely a by-product of simultaneous awards to executives or of firms’ routinely timing all option grants;
  • (iii) Lucky grants to independent directors have been associated with more CEO luck and CEO compensation;
  • (iv) Rather than being a substitute for other forms of compensation, gains from opportunistic timing were awarded to CEOs with larger total compensation from other sources; and
  • (v) Opportunistic timing was not driven by firm habit but rather, for any given firm, the use of such timing was itself timed to increase its profitability for recipients.

Our analysis suggests that the existence of CEO and director lucky grants as a variable that can be useful to research studying the governance and decision-making of firms. We therefore make available on the website of the Harvard Program on Corporate Governance a dataset (available here) of CEO and director luck indicators based on our work.


Here is a more detailed outline of what our paper (available here) does:

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