Executive stock options (ESOs) are used to provide incentives for executives to improve company performance. ESOs are usually granted “at-the-money,” meaning that the exercise price of the options is set to equal the market price of the underlying stock on the grant date. Clearly, executives would prefer to be granted options when the stock price (and thus the exercise price) is at its lowest.

Backdating options is the practice of choosing a past date when the market price was particularly low. Backdating has not, in the past, been illegal if no documents are forged, if communicated to the shareholders, and if properly reflected in earnings and in taxes.

1. Since backdating gives the executive an “instant” profit, why wouldn"t the firm simply grant an option with the exercise price lower than the current market price?
2. Suppose the executive was not involved in back-dating the ESOs. Does the executive face any ethical issues?

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