The chief executives and CFOs of companies accused of backdating stock options for their top executives were likely to lose their jobs and have trouble finding another one, according to a new study.
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The study, which appeared in the current issue of the American Accounting Association journal The Accounting Review, found that top corporate executives who were implicated in the backdating of stock options (enhancing options' value by dating them earlier than the day on which they are issued, a practice of borderline legality) not only were likely to lose their jobs, but had a less than even chance of landing a full-time position at another firm.
Even as the SEC or U.S. Justice Department struggled with the lengthy, arduous challenge of trying to prove fraudulent intent, executives experienced "adverse consequences" from their own companies and the corporate world in general, according to the study. "The likelihood of turnover increases very substantially for the CEO, CFO, and general counsel involved in backdating...and the future employment prospects for backdating executives are significantly worse than for control-firm executives," said the study.
"Private-sector disciplining of executives...provides an important complement to regulatory sanctions," said the study.
CEOs of firms implicated in options backdating were nearly five times more likely to be discharged than were non-backdating chiefs of a control group of similar firms, according to the paper, with 24.1 percent being forced out among the former, compared to 5 percent among the latter. For CFOs, the comparable figures were 24.8 percent and 7.8 percent.
Equally striking was the difficulty that departed executives encountered in gaining new jobs. Displaced CEOs or CFOs of backdating firms were about half as likely as displaced counterparts at non-backdating companies to obtain a comparable position at another public company—18.7 percent compared to 35.1 percent. Their success at landing a full-time corporate job of any kind was less than fifty-fifty (48.4 percent), compared to 83.8 percent for CEOs and CFOs of non-backdating companies. "The lower rehire rate for displaced managers is inconsistent with boards' releasing high-ability managers only to appease regulators or investors," the study noted.
"Since the recent financial crash, we've heard a lot about the need to beef up regulation, along with a fair amount of skepticism that increased regulation will make any difference,” said
Edward P. Swanson, an accounting professor at the Mays Business School at Texas A&M University, who-co-authored the paper with Jap Efendi of the University of Texas at Arlington, Rebecca Files of the University of Texas at Dallas, and Bo Ouyang of Pennsylvania State University Great Valley. “Our findings suggest that it doesn't take a massive bureaucratic effort to penalize higher-ups: corporate boards appear to be willing to take action well before regulators bring their investigations to a conclusion."
"Frankly, our findings came as something of a surprise. After all, backdating stock options in itself isn't illegal, even if much of the accounting associated with it is,” said Swanson. “The whole purpose of the practice is to swell executive compensation, and boards have not been particularly sensitive in the past to public outrage about excesses on this score. What seemed to make a big difference in the case of backdating, beyond adverse publicity, were the launching of government investigations and the frequent need to restate company finances. Official investigations tripled the odds of forced executive turnover, and the issuing of restatements increased those odds by a whopping 13 times. It may be that the public embarrassment occasioned by such episodes induces a sense of betrayal in corporate directors – that is, as long as directors are not recipients themselves of backdated options, which, we found, reduces the likelihood of CEOs or CFOs being forced out."
The research also revealed that the difficulty that dismissed executives encounter in landing another job is not affected by whether backdating resulted in a restatement of financials or a regulatory investigation. "This suggests that all backdating allegations act as a negative signal to the managerial labor market about the individuals' trustworthiness," said the study.
The findings derive from comparing changes in top management that occurred in two groups of companies during the period 2005-07, a time of numerous stories in the business press about stock option backdating.
One group consists of 141 public companies that were alleged by the media or regulators to have engaged in backdating or that issued backdating-related announcements on their own. The second group consists of companies not alleged to have engaged in option backdating but that were matched to those in the first group on the basis of many factors that have been identified as affecting the likelihood of backdating, including length of CEO tenure, existence of interlocking directorships, stock-price volatility, status of the firm's auditor, amount of company assets, and involvement in high technology. Top-management changes were monitored through 2007.
Even harsher than the fate of CEOs and CFOs, the study finds, was that of corporate general counsels, whose turnover rate in backdating firms was 43.2 percent, more than double the rate of 20.9 percent in the control group. In 56 percent of backdating-related GC turnovers, no other top executive was terminated, tempting the study's authors to wonder about scapegoating, especially considering that "regulatory enforcement data indicate GCs were one of the responsible parties, but not the primary responsible party, for option backdating."
In addition to putting top executives at risk, public allegations of backdating also led the implicated companies to considerably diminish the prominence of stock options in CEO compensation. From the year before backdating was alleged to two years after, implicated firms reduced the value of option grants by an average of about 30 percent, compared to an average drop of about 8 percent among companies in the control group.