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However, under the new FAS 123R, the expense is based on the fair market value on the grant date, such that even at-the-money options have to be expensed.) Because backdating is typically not reflected properly in earnings, some companies that have recently admitted to backdating of options have restated earnings for past years. The exercise price affects the basis that is used for estimating both the company's compensation expense for tax purposes and any capital gain for the option recipient.Thus, an artificially low exercise price might alter the tax payments for both the company and the option recipient.ESOs are usually granted at-the-money, i.e., the exercise price of the options is set to equal the market price of the underlying stock on the grant date.Because the option value is higher if the exercise price is lower, executives prefer to be granted options when the stock price is at its lowest.

(Under APB 25, the accounting rule that was in effect until 2005, firms did not have to expense options at all unless they were in-the-money.

This made me think about the possibility that some of the grants had been backdated.

I further found that the overall stock market performed worse than what is normal immediately before the grants and better than what is normal immediately after the grants.

In comparison, had the options been granted at the year-end price when the decision to grant to options actually might have been made, the year-end intrinsic value would have been zero.

Backdating does not violate shareholder-approved option plans.

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