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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.
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.
Most shareholder approved option plans prohibit in-the-money option grants (and thus, backdating to create in-the-money grants) by requiring that option exercise prices must be no less than the fair market value of the stock on the date when the grant decision is made. For example, because backdating is used to choose a grant date with a lower price than on the actual decision date, the options are effectively in-the-money on the decision date, and the reported earnings should be reduced for the fiscal year of the grant.
(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.
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.
Unless corporate insiders can predict short-term movements in the stock market, my results provided further evidence in support of the backdating explanation.