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However, if the company granted options with an exercise price below fair market value, there would be a compensation expense that had to be recognized under applicable accounting rules.
If a company backdated its stock options, but failed to recognize a compensation expense, then the company's accounting may not be correct, and its quarterly and annual financial reports to investors may be misleading.
However, in late 2005 and early 2006, the issue of stock options backdating gained a wider audience.
This is a way of repricing options to make them valuable or more valuable when the option "strike price" (the fixed price at which the owner of the option can purchase stock) is fixed to the stock price at the date the option was granted.
In essence, the revision enabled companies to increase executive compensation without informing their shareholders if the compensation was in the form of stock options contracts that would only become valuable if the underlying stock price were to increase at a later time.
In 1994, a new tax code (162 M) provision declared all executive income levels over one million dollars to be “unreasonable” in order to increase taxes on all applicable salaries by removing them from their previous tax-deductible status.
The SEC’s opinions regarding backdating and fraud were primarily due to the various tax rules that apply when issuing “in the money” stock options versus the much different – and more financially beneficial – tax rules that apply when issuing “at the money” or "out of the money" stock options.
Additionally, companies can use backdating to produce greater executive incomes without having to report higher expenses to their shareholders, which can lower company earnings and/or cause the company to fall short of earnings predictions and public expectations.The other major way that backdating can be misleading to investors relates to the method by which the company accounts for the options.