option backdating

Option backdating occurs when a stock option exercise date is set prior to the date on which the option was granted and at a lower exercise price than the current market price of the company's stock.

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For example, assume that on January 1, 2014, a company's stock is selling for $25 per share. Also assume that the company's chief executive officer (CEO) is given a 4-year option grant covering the period from January 1, 2012, to January 1, 2016, and that on January 1, 2012, the stock was selling for $15 per share. "Backdating" the option grant by 2 years in this instance allows the CEO to purchase the stock at $15 rather than at the current $25 per share price, thereby locking in an automatic profit. Option backdating is legal, provided the backdating is clearly communicated to stockholders and as long as the effect of the backdating is properly reflected in both earnings reports and tax payments. However, there have been a number of lawsuits against corporate directors and officers alleging illegal option backdating in which these conditions were not met.