| During the past 15 years, the most
important component of executive pay packages, and the one .most responsible for
the large increase in the level of such compensation, has been stock-option
grants. The increased use of option grants was justified as a way to align
executives' interests with shareholders'. For various tax, accounting, and
regulatory reasons, stock-option grants have largely comprised "at-the-money
options": rights to purchase shares at an "exercise price" equal to the
company's stock price on the grant date. In such at-the-money options, the
selection of the grant date for awarding options determines the options'
exercise price and thus can have a significant effect on their value. Earlier research by financial economists on backdating practices focused on the extent to which the company's stock price went up abnormally after the grant date, My colleagues and I focused instead on how a grant-date's price ranked in the distribution of stock prices during the month of the grant. Studying the universe of about 19,000 at-the-money, unscheduled grants awarded to public companies' CEOs during the decade 1996-2005, we found a clear relation between the likelihood of a day's being selected as a grant date for awarding options, and the rank of the day's stock price within the price distribution of the month: a day was most likely to be chosen if the stock price was at the lowest level of the month, second most likely to be chosen if the price was at the second-lowest level, and so forth. There is an especially large incidence of "lucky grants" (defined as grants awarded on days on which the stock price was at the lowest level of the month): 12 percent of all CEO option grants were lucky grants, while only 4 percent were awarded at the highest price of the month. The passage of the Sarbanes-Oxley Act in August 2002 required firms to report grants within two days of any award. Most firms complied with this requirement, but more than 20 percent of grants continued to be reported after a long delay. Thus, the legislation could be expected to reduce but not eliminate backdating. The patterns of CEO luck are consistent with this expectation: the percentage of grants that were lucky was a high 15 percent before enactment of the law, and declined to a lower, but still abnormally high, level of 8 percent afterwards. Altogether, we estimate that about 1,150 CEO stock-option grants owed their financially advantageous status to opportunistic timing rather than to mere luck. This practice was spread over a significant number of CEOs and firms: we estimate that about 850 CEOs ( about 10 percent) and about 720 firms ( about 12 percent) received or provided such lucky grants. In addition, we estimate that about 550 additional grants at the second-lowest or third-lowest price of the month owed their status to opportunistic timing. The cases that have come under scrutiny thus far have led to a widespread impression that opportunistic timing has been primarily concentrated in "new economy" firms. But while the frequency of lucky grants has been somewhat higher in such firms, more than 80 percent of the opportunistically timed grants have been awarded in other sectors. Indeed, there is a significantly higher-than-normal incidence of lucky grants in each of the economy's 12 industries. |