Wall Street Journal Reporters Still Getting Backdating Wrong

That Wall Street Journal story we mentioned earlier opens with this tantalizing lede. Too bad it is so misleading.

On Jan. 4, 2002, the chief financial officer of Broadcom Corp. tapped out an email about stock options to his chief executive and others.

"I VERY strongly recommend that these options be priced as of December 24," he wrote.

They were, and that was fortunate for recipients. Broadcom's share price rose 23% between the two dates. The pretense that the options had been granted on the earlier date made them extra valuable.

It also violated the rationale of stock options. They give recipients a right to buy stock in the future at the price when the options are granted, so that recipients can profit only if the price of their company's stock goes up. Setting a lower "exercise price" for the options gives recipients a head start on profiting.

That last paragraph bears re-reading because it is, at the very least, quite contentious for a front-page news story. Remember, this isn't a Ben Stein rant or a Gretchen Morgenson screed. So it unfortunate that the reporters make the mistake of stating the pro-criminalization, anti-backdating case as a matter of fact.

Backdating does not necessarily "violate the rational of stock options." This is a point we made a long, long time ago. First of all, even the reporters statement of "the rationale" is questionable. There are many rationales for granting stock options. In addition to tying employee compensation to stock performance, stock options also allow a company to provide compensation to valuable employees without diminishing their immediate cash position. What's more, some employees prefer stock options to immediate cash payments because they want to participate in the potential upside growth of their companies. There are also powerful tax-incentives for accepting stock-options, since they are usually not taxed until a gain is realized.

More importantly, none of these rationales (save, perhaps, for the tax-deferment) is violated by granting backdated stock options. This should even be obvious for the rationale preferred by the Journal reporters. Holders of backdated stock options may have a "head start" on their options—the options are actually in the money when granted—but they still must usually hold the options for years before they can be cashed in, and their profits still increase with the rise of the share price. Their incentives are thus aligned exactly with those of other shareholders.

Backdating involved violations of some very complex accounting rules. And reporters, investigators and shareholders certainly have every right to expect companies not to play fast and loose with these rules. But it doesn't help the public understanding of this mess to paint backdating as some sort of corporate looting or embezzling or to pretend that backdating stock options destroys the very rationales for granting them in the first place.

Probes of Backdating Move to Faster Track [$$] [Wall Street Journal]