Options backdating is a strategy in which options are granted to an investor based on a date when the value of those options was lower than the current share price. While this type of activity is not considered illegal in most nations, there is some question in some quarters as to its ethical implications. In actual practice, options backdating makes it possible for investors who are granted the shares to immediately realize a return, since the older share price has already been superceded by the most recent and higher price per share.
One of the more common situations where options backdating takes place is in assigning shares of company stock to employees. As part of the employee stock option, the business identifies a specific date in the recent past to serve as the benchmark for pricing the value of those assigned shares. For example, XYZ Company may decide to award an executive with a thousand shares of preferred stock on 31 December, when the stock is trading at a rate of $50 US dollars (USD) per share. Instead of using the current trading value, the company might decide to use the price that the shares were trading at on 1 December, which was $40 USD per share. This means that the executive immediately generates a return of $10 per share on each of those thousand shares.
In terms of arranging the paperwork, the issuer will make use of the actual date associated with the price used in the transaction. This means that even though the shares were assigned on 31 December, the options backdating process requires that the documentation carry the date of 1 December, effectively justifying the price used in the transaction. As a result, the actual date of granting associated with the shares is not the same as the grant date carried in the paperwork.
There is some difference of opinion as to how effective this process actually is, in terms of promoting more efficiency among executives. Proponents see the immediate reward gained from the use of options backdating as being an incentive that encourages the recipient to be more committed to the employer. Opponents note that once this immediate reward is granted, the executive has little incentive to work harder and encourage the growth of the business, an action that would likely result in increasing the value of the stock.
In some countries, any incidences of options backdating must be reported to the national regulatory agency that oversees trading and investment activity within that particular nation. Often, time limits are imposed that prevent the backdating process to utilize a price that applies to a date outside a defined range. For example, the agency may allow a company to issue the shares to corporate executives at a price that applied to any date in the two calendar months prior to the date the shares are assigned, but would disallow the use of a price that went back three months.