You may be familiar with the backdating scandals of the recent past, in which it was revealed that some corporations retroactively dated options awards to senior executives to maximize the financial value of those awards.
Today’s Wall Street Journal includes an article (subscriber link) discussing another dimension to the scam — using backdating to reduce taxes:
In a paper that began circulating in recent days, a Securities and Exchange Commission economist concludes there is strong statistical evidence that executives manipulated the exercise dates of their options as part of a tax dodge. And a review of corporate filings turns up some companies with startling options-exercise patterns.[...]
Consider an executive who holds options on 100,000 shares with a strike price of $10. If he exercises and sells when the price is $20, he realizes $1 million in income and must pay $350,000 in income taxes.
If he instead can claim an exercise price of $16, he lowers his income tax to $210,000. If he then sells a year later and the stock is at the same price of $20, he pays $60,000 in capital-gains levies, for a total tax bite of $270,000. In other words, he has the same $1 million gain but saves $80,000 in taxes. The problem arises if the executive misrepresents when the exercise occurred to claim a lower exercise price.
The article mentions that the patterns discussed in the SEC paper disappeared once Sarbanes-Oxley came into force.