A new study titled "Lucky CEOs" presents the investigation of the opportunistic timing of stock option grants from 1996 through 2005 using regression analysis and other statistical methods. The results of the analysis are astounding, and they indicate that the ethics and governance reforms initiated by the Sarbanes-Oxley Act (SOX) may need to be strengthened, rather than weakened, which many corporate critics have demanded of the Securities & Exchange Commission (SEC) and Congress. The authors--Lucian Bebchuk, a Harvard Law School professor; Yaniv Grinstein of Cornell University; and Urs Peyer of INSEAD--believe that manipulative grants were more prevalent in corporations where SOX reforms were most necessary--those that had a minority of independent directors and/or where the CEO had longer tenure.
The study identifies possible opportunistic manipulation of dates on which option grants were priced. "Lucky grants" were defined as grants that were priced at the very lowest of the price distribution in the month granted. Of the nearly 20,000 unscheduled option grants that were made by about 6,000 firms during the 10-year period, the study estimates that 2,330 grants (12.2%) fit the definition of "lucky." Of this number, about 1,160 (49.8%) are estimated to be associated with the manipulative backdating practice. The authors conclude that the pricing manipulations resulting in lucky grants were substantially due to backdating rather than the practice of spring-loading based on inside information. Backdating took place both before and after the enactment of SOX.
The authors found that approximately 42% of the lucky grants were actually "super-lucky," which they define as grants priced at the lowest price during the calendar quarter in which they were awarded. Of these, the authors estimate that about 62% of them were the result of price manipulation. An interesting finding is that lucky grants seemed to be concentrated in some companies. The likelihood that a company would award a lucky grant was nearly twice as great for a company that had previously awarded one compared to companies that had not.
The authors found no evidence to support the widely held belief that companies providing backdated options reduced compensation paid through other means. On the contrary, total reported compensation from normal sources was higher for firms awarding lucky grants than for those that didn't. Further, in contrast to the common impression that grant price manipulation was largely concentrated in new economy firms, the practice appears to be widespread in old economy firms as well. A majority of the estimated manipulated lucky and super-lucky grants were awarded by old economy firms, reflecting the larger number of old economy companies. This finding seems to conflict with evidence from disclosures of actual grant pricing difficulties, which is discussed next.
The average gain from the lucky grants was more than 20% of the reported value of the grant, increasing the CEO's reported compensation for the year by more than 10% on average. In summary, with significance at the 1% level, the study showed that lucky grants were:
* More common when the CEO had a preceding grant that was lucky;
* Less frequent in companies whose board of directors contained a majority of independent directors;
* More frequent among CEOs with longer tenure and larger ownership stakes;
* More frequent among new economy firms;
* More frequent among smaller firms;
* Less frequent after SOX was adopted; and
* More frequent when the stock price was volatile during the month.
It seems evident that only vigorous enforcement action by the SEC and Department of Justice (DOJ) will allow the governance reforms contained in SOX to achieve their objectives and be effective. Any attempts to weaken SOX provisions or reduce their enforcement effort are …