On the Benefits of Backdating

32 Pages Posted: 31 Jan 2007

See all articles by Martin Dierker

Martin Dierker

University of Houston - C.T. Bauer College of Business

Thomas Hemmer

Rice University - Jesse H. Jones Graduate School of Business

Date Written: January 30, 2007

Abstract

In this paper we examine options backdating from a wider agency perspective. Recognizing that any options grant will always create timing incentives for managers, we show how the more flexible choice of a grant date implied by backdating actually can mitigate such agency problems. In the absence of backdating, managers can always time investments as to maximize the value of their expected future option grants. While there is no particular wealth-transfer implication of backdating as the wealth consequences are known and can be adjusted for at the time of grant, investment delay however comes at a real economic cost to shareholders. Viewed from an economic perspective, thus, backdating if done right is a shareholder value maximizing feature and thus worth preserving. Explicitly incorporating option pricing theory allows us to quantify managers' incentives. The commonly awarded very long maturity options minimize the sensitivity of the option value to the strike price, and thus minimize moral hazard ahead of an option grant. Our modelling leads to sharp testable implications.

Keywords: backdating, executive compensation, stock options, investment timing

JEL Classification: G30, J33, M52

Suggested Citation

Dierker, Martin and Hemmer, Thomas, On the Benefits of Backdating (January 30, 2007). Available at SSRN: https://ssrn.com/abstract=960286 or http://dx.doi.org/10.2139/ssrn.960286

Martin Dierker (Contact Author)

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States
713-743-4777 (Phone)
713-743-4789 (Fax)

Thomas Hemmer

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States

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