Our analysis provides new insight into how boards function and the role that they play in providing managerial oversight and determining corporate strategy.
There is now considerable evidence suggesting that a large number of firms in the United States have engaged in the practice of backdating stock option grants awarded to their executives.
While the above facts suggest that by 2002 option backdating had become widespread, little is known about how this practice began and how it proliferated across firms.
In our sample, about 10% of firms reporting an option grant in 1996 demonstrate evidence of backdating.
We examine the role of board connections in explaining how the controversial practice of backdating employee stock options spread to a large number of firms across a wide range of industries.
Much of the existing research on board interlocks examines the relationship between CEO pay and board interlocks (e.g., Hallock 1997; Core, Holthausen, and Larcker 1999; Fich and White 2003; Barnea and Guedj 2006; Larcker et al. While we also provide some insight into how board connectivity contributes to agency problems and increases in CEO pay, our focus is different.We focus on the role that director interlocks played in contributing to the spread of backdating.The board of directors has primary authority over the level and structure of executive compensation, including determination of the amount and timing of option grants.The practice of backdating involves the board of directors “looking back” in time to select favorable dates to grant stock option awards (e.g., when the stock price was at its lowest).By looking back in this manner, firms can make it appear that the option award was granted at an earlier date and at a lower exercise price compared to the actual date the award was approved.