The most recent corporate scandal, backdating stock options, involves (alleged) violations of duty by company management, the grant dates being deliberately backdated to take advantage of lower stock prices. The assumption is that the exercise (or strike) price of employee stock options legally must be fixed at fair market value as of the grant date; deliberately backdating is per se a fraud because the favored grantee was issued options “in the money.”

Why were so many boards and compensation committees seemingly cavalier about the strike price? Why weren’t they scrupulously careful, ensuring fair market value was arrived at in “good faith” (the Internal Revenue Code standard). Without pretending inside knowledge, my assumption is that, at least in many instances, the boards believed that not much hung on the outcome. During the periods in question, there was nothing wrong in awarding stock options “in the money” as of the date of the award. Such options are known as ‘non-quals’ and are customarily used in lieu of or in addition to incentive stock options, the latter requiring that the strike price be set at fair market value on the grant date.