Impact of backdating
Therefore, the alternative hypothesis we propose, which we broadly label Agency Hypothesis, is that a firm’s involvement in the backdating scandal has significant economic implications, despite its limited (direct) impact on cash flows.
Under this hypothesis, the losses generated by the option backdating scandal can arise because management’s involvement in backdating practices may prompt investors to reassess the agency costs stemming from the separation of ownership and control.
Listed firms in the Netherlands have a long tradition of employing many anti-shareholder mechanisms limiting shareholders rights.
Our results imply that insider transactions are more ..." We investigate patterns of abnormal stock performance around insider trades and option exercises on the Dutch market.
A series of multivariate show that measures we expect to be related to the effect of the scandal on the value of firms’ reputational capital and information risk are significantly related to changes in shareholders’ wealth.
Conversely, variables one would expect to be related to the magnitude of direct out-of-pocket expenses, namely the number of past grants and/or their value, are not significantly related or are positively related to shareholders’ wealth effects, inconsistent with the direct cost hypothesis.
Firm announcements of backdating have lead to adverse publicity from the media and negative pronouncements from academics regarding the economic effects and motivation of those involved.
This research finds that backdating signals to the capital markets that these firms have ineffective governance systems and poor internal controls.
This indicates negative media attention and unwarranted impact on share prices, in many cases. We investigate patterns of abnormal stock performance around insider trades and option exercises on the Dutch market.
We are also grateful to Sandro Andrade, Jennifer Carpenter, Jay Emerson, Doug Emery, Yaniv Grinstein, Shane Heitzman, Xi Li, Evgeny Lyandes, Howard Mulcahey, Robert Neal, Katherine Schipper, Douglas Skinner, Jerry Zimmermann, seminar participants at the University of Miami and the Securities & Exchange Commission (SEC), and participants of the 2007 Journal of Accounting & Economics Conference and the Western Finance Association 2008 Meetings for their comments and suggestions; and to Hernan Awad for his invaluable help in designing the Monte-Carlo simulations used to compute the grant dates’ odds.
Finally, we gratefully acknowledge the special efforts and contributions in support of this study by Michael Schwert, Duke University, and Erin Redoutey and Raul Izquierdo, Univeristy of Miami.
We also find that institutional investors reduce their holdings in firms accused of backdating, possibly due to higher monitoring costs, and that firms involved in the scandal are very likely (10% of the sample) to receive arguably fair takeover offers.
Overall, the evidence is consistent with the hypothesis that the loss of investors’ confidence in the firm’s management is a first-order determinant of the economic consequences resulting from the option backdating scandal.
In contrast, backdating firms dress up their board-level governance to meet regulatory requirements but still feature weaker committee-level corporate governance in the post-SOX era.