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BACKDATED STOCK OPTIONS
What Are Stock Options?
Stock options are a form of
compensation to corporate employees,
such as directors and officers,
designed to create incentives to
boost profitability and increase
stock value. A stock option gives
the right to purchase company stock
at a pre-set price – which is called
the “exercise price” or the “strike
price” – irrespective of the actual
trading price when the stock is
exercised.
If, subsequent to the grant of a
stock option, the company’s stock is
trading at a price below the
option’s exercise price, then the
stock option is considered to be “in
the money,” meaning that if the
option were exercised, the stock
could be obtained for a price less
than its cost on the open market,
thereby ensuring an instant profit.
Conversely, if the price of the
company stock dips below the
exercise price, the stock option is
considered to be “out of the money,”
meaning essentially its exercise
would yield an instantaneous loss.
“Out of the money” stock options are
therefore valueless.
The exercise price is supposed to be
determined on the date that the
stock option is granted and is
usually the stock’s closing price
that day. When granted in this
fashion, and when properly accounted
for on a company’s public filings
with the Securities and Exchange
Commission (SEC), stock options are
perfectly valid and quite common.
Company stock option plans, which
are approved by shareholder vote,
and employment agreements are
employed to determine how many stock
options are to be granted to
officers, directors, and employees,
and in what manner. Once a stock
option plan is in place, the
Compensation Committee of a
company’s Board of Directors
approves individual stock option
grants. The Compensation
Committee’s role in granting options
is to ensure that they are fair to
the company’s shareholders and do
not unjustly enrich the officer or
director receiving the options at
the expense of the corporation. In
fulfilling this important role,
members of the Compensation
Committee operate under fiduciary
duties of care, loyalty, and good
faith.
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