Dr. Renzo Comolli and 3 of his colleagues at NERA provide an exhaustive and scholarly economic analysis of backdated options in a very recent paper entitled: Options Backdating: The Statistics of Luck. In particular they point out statistical flaws in an article by The Wall Street Journal and much other mainstream reporting on the topic. Here are the concluding paragraphs of the article, which is replete with charts and graphics that explicate the authors’ findings:
If, in fact, companies are more likely to issue grants when they perceive their stock to be undervalued, investors may take the news of a grant as a signal to purchase the stock, thereby causing the price increase. Therefore, a high return following a grant may be a result of an increase in demand for the stock of the issuing company by investors. Thus, it may be appropriate to disentangle the price movement after a grant from the price movement after the news of a grant is on the market.
What’s Next?A lot of misconceptions have been circulating about options backdating and in particular about the statistical calculations that have been used in connection with it. On the one hand, the academic literature studying aggregate price pattern following option grants is comparatively recent and no methodology to disentangle illicit practices from legitimate ones has consolidated yet. On the other hand, we have discussed and presented corrections for some conceptual errors regarding the probability calculations concerning specific companies or specific insiders. Each new case may present some specific characteristic that challenge economists to rethink their method to arrive to the correct conclusion.