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What John Mack’s $40M Tells Us About Backdating

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One of the most misguided notions about backdating holds that the practice typically worked in exactly the opposite way it typically did. Because of confusing accounts in the financial media, lots of people seem to believe that companies were first making decisions about how many stock options to grant their executives, and then sneakily inflating the value of those options by pretending they were granting them on an earlier date. In fact, some of you reading this probably thinks that’s how it worked.
But you know what? That’s not how companies grant options at the highest levels. They do it like Morgan Stanley did. And how’s that? Well, let’s look at it this way: do you think that Morgan Stanley’s compensation committee got together and said, “Hey. I think John Mack deserves 461,821 shares of common and options to buy 178,945. Get the accountants to figure out what that’s worth.”
Of course not. You know that what happened is this: the board decided to give John Mack a $40 million bonus, and afterwards figured out how many shares that equaled at the current stock price.
And that’s how backdating typically operated. A board would decide to give an executive a bonus worth a certain amount, and then figured out how many stock options it needed to dish out to equal that amount. Pushing the date of the grant back to a day when the stock was trading a lower price simply allowed them to grant fewer options—since those they were now worth more. What’s more, they showed up as lower cost on the companies balance sheets and didn’t provoke immediate taxes for the recipient the way an “in the money” option would have.
In short, backdating (for the most part, probably) wasn’t a way of inflating executive pay. It was a way of paying executives exactly what the board wanted to with less cost to the company and the executive.