"I don’t think at the time we had a sense of the impact this research would have on corporate governance," says Heron, an associate professor of finance at the Kelley School of Business at Indiana University.
Heron and Lie, an associate professor of finance at the University of Iowa’s Tippie College of Business, knew stock prices dipped sharply before executives cashed in their stock options and increased sharply afterward. The professors then used their data and changes in SEC regulations to posit that executives were not simply using insider knowledge to time their stock granting dates with positive company news. Instead, they were granting their options by going back in time to the lowest possible price point, a move that reaped billions of dollars at great expense to shareholders. Lie and Heron took their data to the Securities and Exchange Commission, which has since launched an investigation into the practice, and to The Wall Street Journal, which in March exposed backdating by several companies.
"We contacted The Wall Street Journal and said, ‘This is actually a whole lot more widespread than what you think,’ " Lie says.
The practice indeed was widespread. Several thousand companies have at least one manipulative grant date between 1996 and 2002, Lie says. About 250 companies will have to restate earnings by the end of the year, and as many as 100 company executives have resigned as a result. In an Enron-like echo, employees and shareholders have watched stock values—and the value of their portfolios—drop. Regulators claim that backdating options violates disclosure, tax and accounting laws. The scandal has prompted the SEC to investigate more than 200 companies.
The professors’ research has led to a rethinking of how the favorable treatment given to executives can sometimes come at the expense of rank-and-file workers and shareholders.
"A lot of people have lost their jobs," Lie says. "A lot of good people do stupid things. They should be held accountable, but it is still sad."
Background: Erik Lie and Randall Heron met in 1992 at Purdue University. Both were pursuing their doctorates in finance and, as luck would have it, they ended up sharing an office from 1994 to 1995. The two have collaborated on at least seven academic papers. The full story on their academic research into backdating will be published in a forthcoming article in the Journal of Financial Economics.
Workforce Management, December 11, 2006, p. 23 -- Subscribe Now!