Business ethics of stock option backdating at Apple

Running head: BACKDATING 1

BACKDATING 6

Business Ethics: Backdating and Repricing of Stock Options

Business Ethics: Backdating and Repricing of Stock Options Q1. Explain in detail what is meant by the backdating and repricing of stock options. Be specific. Trust and a belief in organizational transparency is necessary for businesses to function at an optimal level. This is one reason for the passage of the Sarbanes-Oxley Act of 2002 after the WorldCom and Enron scandals unsettled the business world, particularly in regards to accounting practices. Still, backdating and repricing of stock options continues to be an ethical problem within many organizational contexts. Stock options, or the ability to purchase company stock, are commonly given to enhance employee compensation packages, particularly those of executives. The price is linked to the market price at the day of issuance, allowing the company to avoid recording it as a compensation expense and the employee to avoid being taxed on what effectively is a salary but is given in the form of common stock; taxes on stock options only have to be paid when the options are sold (Raiborn, et al., 2007). Options are often cited as a way of ensuring that executives have a stake in the financial health and future of the company, given that if the company performs well, the executive will benefit on a personal level, but if the company does not, the executive must suffer the decline in the performance of the stock and lose income. Backdating, however, reprices the value of the stock to an earlier share price. “The executive benefits from the reduction in option price, but the company and the other non–stock-option-holding investors face a lowered net income, which, in turn, could generate a lower share price,” thus acting to “reward executives for corporate difficulties, rather than hold them accountable” (Raiborn, et al., 2007, par.7). This reduces the financial incentives for executives to perform at a high level and also unfairly takes away profits to which ordinary shareholders are entitled. Q2. Conduct research regarding a SEC investigation of Apple backdating its stock options and the deposition of Steve Jobs. Summarize in your own words the results of that disposition. Did anyone at Apple get into trouble with the SEC in regards to the backdating of the stock options? If so, who and why? Despite the largely laudatory coverage of Steve Jobs’ tenure at Apple, there were some dark clouds regarding the ethical actions of his leadership, including his actions in regards to stock options. “In 2001 he was granted stock options amounting to 7.5 million Apple shares, allegedly without the required authorisation from the company\\\\\\\'s board of directors,” at a lower price than was actually offered on the general market, “incurring a taxable charge of $20 million that Jobs did not report as income” (Worstall, 2011, par.1). Even Apple’s own internal audit found that the options had not been recorded properly, but Jobs returned then without exercising them, pleading ignorance. Similarly, the SEC declined to file charges against Jobs, although two former executives were charged for their roles in improperly accounting for backdating Apple stock (Worstall, 2011). Worstall (2011) notes that backdating itself is perfectly legal. But it is still an expense to the company and as such should be reported in Apple’s recorded profits as an expense which naturally reduced profits by $20 million lower because of the outlay effectively paid to Jobs. Apple did not record that as an expense. This is not only unethical and a misrepresentation but shareholders “make decisions about the future, whether to buy, sell or hold, stocks based upon quarterly profit reports,” which are naturally affected by the appearance of profits or losses recorded by the organization (Worstall, 2011,par. 8-9). Ultimately, financial records should be accurate. Apple found improper recording of backdated stock a relatively easy accounting maneuver to fabricate and its size and power as a corporation may have caused regulators to turn a blind eye to its chicanery. Q3. Comment on the ethics of backdating stock options. Summarize the best and most authoritative literature you can find on this subject. Do you believe that either the backdating or the repricing, or the combination of backdating and repricing at the same time, constitutes an act of fraud? Why or why not? Be specific. Backdating of stocks is legal, although many financial ethicists have called into question its ethics. The example of Apple illustrates the extent to which share prices can be easily manipulated and skirt the technical letter of the law. Even when perfectly legal, the fact that executives can benefit from poor company performance is extremely troubling. Other than executives, there is ample evidence that creative manipulation of stock prices does investors very little good. For example, “if the company has to acquire treasury stock in the future to satisfy option holders upon exercise, the market activity could create an even higher price and greater gains to the exercising employee” and while it would help all stockholders, it could also make it artificially more difficult for prospective investors to acquire the stock at a fair market price (Raiborn, et al., 2007, par.8). The purchase and sale of stock is already a privileged business, given the level of its complexity often makes it very difficult for the average investor to navigate the marketplace. The existence of stock options alone is a privileged benefit in addition to astronomical salaries for CEOs. Repricing loopholes in the law further serve to accentuate these asymmetries and do not benefit ordinary shareholders or even lower-level employees with stock options, as “options for high-level executives were repriced while those of lower-level employees were not (or were not repriced to the same degree)” further not holding executives responsible for their actions which may have precipitated the drop in price in the first place (Raiborn, et al., 2007, par.8).