Does backdating explain
compensation committees just don’t “get” that options are valuable and so give them out like candy.As far as economic explanations go for the trends in executive compensation generally, and the increasing prevalence of backdating specifically, I find naivety from the economic actors concerning option value to be a particular unsatisfying explanation for a trend this robust.Erik Lie is a Norwegian finance professor at the University of Iowa who published a report about options backdating that led to many investigations by the SEC into the potentially illegal practice.He was the subject of profile in Business Week for his contribution to uncovering options backdating scandals.Holman Jenkins reports that a group of economists led by Milton Friedman and Harry Markowitz are getting behind the idea of putting an end to the expensing of options. Jenkins goes on to discuss options backdating and makes the following points, which will sound unfamiliar to TOTM readers: Geoff made exactly these points in this space months ago (and also more recently, here).Personally, I am thrilled to see a column that focuses on the real questions surrounding backdating: (1) Why do firms backdate? and (3) What is the theory of harm, if any, upon which we are going to base civil and criminal prosecutions?is there a reason to believe that backdating became a comparatively attractive form of fraud in the 1990s relative to other methods of accomplishing the same task?I haven’t seen any evidence to support this claim, though it may exist.
Without an efficiency explanation for these practices and trends generally, it is tempting to appeal to intuitive notions of “stealing” or assert that compensation committees “just don’t get it.” This, in my mind, is a tendency not unlike the one described by Ronald Coase in the antitrust context regarding economists’ preoccupation with the monopoly problem: “If an economist finds somethingâ€”a business practice of one sort or otherâ€”that he does not understand,he looks for a monopoly explanation.
For example, Geoff makes the following basic (and sadly overlooked) points: Assuming for the moment that backdating is as rampant as the Lie study, media reports, and sudden wellspring of law firm and litigation consultant “backdating” teams suggests, it might be prudent to ask: “why? ” The only answers to the “so what” question have been assertions about shareholder exploitation and comparisons to Enron.
As to “why backdating,” there seems to be little interest in figuring out what economic and institutional conditions led to the widespread adoption of option backdating and whether the practice is an efficient element of a compensation contract or something more sinister.
But it is not obvious that the American system of executive pay â€” taken as a whole â€” is excessive or broken.
The critics contend that chief executives cheat public shareholders.