The stock option backdating scandal that erupted in 2006 involved over 140 companies manipulating grant dates to maximize executive compensation at shareholders’ expense. While the Sarbanes-Oxley Act’s two-day reporting requirement largely eliminated traditional backdating by 2002, new schemes have emerged. Recent research reveals “Dating Game 2.0” where executives manipulate stock prices around scheduled option grants, creating the same artificially advantageous conditions that backdating once provided.
Stock options give employees the right to purchase company shares at a fixed “strike” price for a specified period. The lower the strike price relative to future stock value, the more valuable the option becomes. Companies traditionally granted options “at the money” – with strike prices equal to current market value.
Backdating involved altering option grant dates to earlier periods when stock prices were lower, effectively giving executives instant profits. For example, if a stock traded at $10 when options were actually granted but had been $7 three months earlier, executives could backdate the grant to the $7 price point.
Professor Erik Lie of the University of Iowa first exposed this practice in 2004, demonstrating that the consistent profitability of executive options was statistically impossible without manipulation. His research estimated that 29% of 7,774 companies surveyed engaged in backdating between 1996 and 2002.
While traditional backdating became nearly impossible after Sarbanes-Oxley, two related practices persist:
Spring loading occurs when companies grant options shortly before releasing positive information expected to drive stock prices higher. The 2020 Eastman Kodak controversy exemplified this practice when the company granted 1.75 million options just before announcing a government loan that briefly sent shares soaring.
Bullet dodging involves delaying option grants until after negative news causes stock prices to fall. This creates more advantageous strike prices for option recipients.
Stanford research has identified a more sophisticated scheme where executives manipulate business decisions to create temporary stock price dips before scheduled option grants. Companies show abnormal negative returns of 1.9% in the 90 days before grants, followed by abnormal positive returns of 1.1% in the 90 days after.
Warren Buffett has consistently argued that stock options represent real costs that must be properly accounted for. In his 1985 letter to Berkshire Hathaway shareholders, Buffett challenged executives who claimed options were difficult to value by offering to pay cash for any executive’s option in exchange for their future gains.
Buffett has maintained that stock options create “broken incentives” for managers and are typically not good for shareholders. He argued that if options truly aren’t costs, executives should be comfortable using them to pay for insurance and other expenses.
Modern accounting standards under ASC Topic 718 (formerly FAS 123R) require companies to expense stock options at fair value. This involves calculating fair value using models like Black-Scholes or binomial approaches, then amortizing the expense over the option’s vesting period.
The Sarbanes-Oxley Act requires companies to report option grants within two days, making traditional backdating nearly impossible. However, the SEC continues issuing guidance on proper accounting for questionable practices like spring loading.
Despite reforms, fundamental conflicts remain. Companies routinely set option strike prices at temporary low points they would simultaneously argue don’t reflect “true business value” if asked to sell the company at those same prices. This mental gymnastics allows executives to benefit from market volatility while claiming their compensation aligns with performance.
The same executives who once resisted expensing options as “too difficult to value” expected shareholders to accurately price these instruments with incomplete information – a contradiction that reveals the self-serving nature of many compensation arguments.
The following commentary was originally published in LIPPER HedgeWorld on October 6, 2006. Remarkably, nearly two decades later, the core issues remain virtually unchanged—though the tactics have evolved from crude backdating to sophisticated timing manipulation.
In 2006, as over 120 U.S. corporations faced investigation for backdating employee stock options, I wrote:
“It is difficult to find an appropriate reward for this creativity, but the SEC is trying its best… Since finance doesn’t have a comparable award, I will initiate one now. The Golden Fleece Award for Optional Integrity goes to the corporate executives who backdated the employee stock options they awarded themselves and failed to specifically disclose this material information to their corporate directors and shareholders.”
What struck me then—and remains true today—is the breathtaking mental gymnastics executives employed:
“Yet if you asked the executives to sell the company at the same dip in the market price (thus potentially jeopardizing their jobs), they would balk, protesting the depressed market price didn’t reflect the true business value. After all, they would argue, they have a duty to the shareholders.”
This corporate doublethink persists in 2025. Companies still set option strike prices at temporary market lows they would simultaneously dismiss as unrepresentative if selling the business.
In 2006, I predicted that creative executives would find new ways around reforms:
“When stock options are immediately expensed, the cost becomes transparent. The methodology employed in expensing the options would very likely have exposed backdating. More employees would have been involved, making it very difficult to keep this sensitive information contained in the small circle of senior executives with the most to gain.”
Indeed, executives adapted. Unable to backdate secretly, they moved to “Dating Game 2.0″—manipulating business timing around scheduled grants to achieve the same result.
Academic defenders of non-expensing in 2006 included Nobel Prize winners Milton Friedman and Harry Markowitz, who argued that “stock prices reflect the liability overhang of employee stock options, implying that shareholders know how to efficiently value these stock options.”
I responded then as I would today: “But shareholders shouldn’t have to make an independent correction for material information that has been omitted from financial statements… The apologists’ claim is especially ironic given that many corporate executives formerly resisted expensing stock options claiming they were too difficult to properly value even when they possessed transparent information about the terms and conditions. Yet shareholders are apparently so skilled, they can price options when the terms and conditions are opaque.”
Warren Buffett’s 1985 challenge to stock option apologists remains unanswered: he offered to pay substantial cash sums to any executive in exchange for their option gains, proving options have real value and represent real costs.
His 2004 admonishment to Congress applies equally today: “Legislators should remember that it is better to be approximately right than precisely wrong.”
Then (2006): Crude backdating to the lowest historical prices
Now (2025): Sophisticated timing manipulation around business decisions
Then: Resistance to expensing options
Now: Options properly expensed, but timing games persist
Then: 45-day reporting windows enabled manipulation
Now: Two-day reporting prevents backdating but not spring loading
Then: Limited academic research on manipulation
Now: Extensive documentation of new schemes, yet they continue
The original Golden Fleece Award for Optional Integrity recognized executives who “backdated the employee stock options they awarded themselves and failed to specifically disclose this material information.”
Today’s award should recognize the evolution of this creativity: executives who manipulate business timing, delay beneficial projects, and orchestrate temporary stock price movements—all to achieve the same self-enrichment that backdating once provided, just with more sophisticated methods.
The tools have changed. The greed remains constant.
While traditional backdating has largely disappeared, the fundamental incentive to manipulate option timing persists. As Stanford’s research shows, “Dating Game 2.0” may actually be worse than original backdating because it distorts stock prices for months and gives executives incentives to delay beneficial projects.
Warren Buffett’s core insight remains valid: stock options are real costs that transfer value from shareholders to executives. Proper accounting, transparent disclosure, and mechanical granting procedures remain essential safeguards against creative compensation schemes that prioritize executive enrichment over shareholder value.
The Golden Fleece Award for Optional Integrity should now recognize not just historical backdating, but the ongoing evolution of timing manipulation that continues diluting shareholder value in favor of executive gain.
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