Ooh. This is bad. Scandals. Jail. Silicon Valley soap opera.
When an important employee is hired by a young company, they might get a generous option plan for company stock and a more modest salary and bonuses. Why? Because young companies don't have a lot of cash now but want to attract good workers, and they're betting on the fact that employees will be tempted by the possibilities of those options.
There are usually some limits with the options. For example, the employee might have to stay in good standing at the company for 4 years and must sell their options within 10 years or so of them being granted. So far so good, but these options must also come with a strike price, which is the price at which the employee can buy the stock. That's where things can get sticky. How is this strike price created? Usually by looking at the average closing price over the last 120 days of trading or something like that.
Some shady companies (and employees) realized that they could backdate their options, which means slapping on a price from a date a few days, a few weeks, or a few months earlier (when prices were lower). Getting that lower price by fudging a few dates means bigger potential profits for the employees who will eventually sell the stock.
Just one tiny problem: backdating is illegal.
In 2008 and 2009, though, it didn't prevent some big backdating scandals in Silicon Valley. Since then, laws about backdating have gotten stricter.
Example
XYZ stock was at $80 a share 20 weeks ago; now it's at $200. In 4, years it might be at $400. The employee getting the $80 strike price on 100,000 shares will have appreciated $320 per share times 100,000 shares or... $32 million. But if the employee had received as their strike price the average of $200 and $80, assuming an arithmetic set of closing price gains, the strike on their options would have been $140. The gain would then only be an appreciation of $260 or $26 million.
Related or Semi-related Video
Finance: What is a Strike Price?40 Views
Finance a la shmoop what is a strike price well before going
even a second further with this video be sure you've seen our Steven Spielberg [Introduction to a movie at the cinema directed by Steven Spielberg]
directed what is a stock option video here are the reviews from variety.. well
to review a stock option is the right to buy a share of stock for a set price
over a given period of time so let's say you were granted an option to buy a [Graph of amazon stock prices]
share of Amazon stock in 2015 when the stock was around 400 bucks a share the
option lasts as long as you work at the company in good standing or after 10
years have passed which ever ends first well one day you decide you want another job [Woman signing a contract]
your contract says that if you're no longer an employee with the company then
you have 90 days in which to either buy out your option that is to buy the
option and then own the stock or just forfeit the option [Woman underlining words on a contract]
well since Amazon is now at a thousand bucks a share you obviously don't want
to forfeit the option to buy that share of stock for 400 bucks but you note that
your many friends who joined apcray.com at a high price a high strike price which
creators know they're stock while they're doing a lot of option forfeiting
that is their options ended up being worthless so you've got a lot to think [Man holding out a bag of dog poo]
about here this is Amazon not apcray so you want to buy out your option so
what happens well you were granted your own options at the price Amazon stock [Amazon box falls off shelf]
was trading at the day you joined the company it was 400 bucks a share so
that's a strike price that $400 is the price you pay to buy a share of stock at
some point there in the future that strike price has nothing to do with [Protestors holding signs outside an Amazon building]
unions not working got it? all right well in order to buy that stock it's
currently trading in a thousand bucks a share
you pay Amazon 400 bucks and that buys out your option you then own the stock [Man writing a check to Amazon for 400 dollars]
that's it Amazon cancel your option then they give
you a share of actual stock which you now own for as long as you want to own [Man delivering an Amazon box]
it you can sell it immediately and make a
$600 a share profit that's a thousand bucks a share it's trading at now minus the
$400 strike price you just paid to buy out that option got it or you can hold [Grandparent bribing grand-daughter for amazon stock]
onto those shares and you know use it to bribe your grandchildren one day it's
worth like a million dollars a share
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