Stock Option Manipulation – Role of Independent Directors in Question

Outside directors are suppose to be the watchdogs of shareholders by bringing an objective and detached view to the board room and providing a check on management.  Yet, a new study in what seems to be an ever-expanding series on option backdating now questions the role of such directors. 

Yesterday, the NYT discussed a study sponsored by the Harvard Law School Program on Corporate Governance that suggests stock option manipulation extends not only to executives, but also to outside directors. See Eric Dash, “Study Finds Outside Directors Also Got Backdated Options,” 12/18/06.  The study alleges that upwards of 1,400 outside directors may have received manipulated options and is the first study to measure the extent of outside directors who directly benefited from the practice. 

The study analyzes roughly 30,000 directors who were granted stock options from 1995 to 2005 and compares the percentage of grants made at monthly low prices with the portion they expected had they been randomly assigned.  The study concludes that out of all director grant events, 9% were lucky grant events, i.e., falling on days with a stock price equal to a monthly low.  Surprisingly, contrary to common belief that outside director options were typically awarded around the time of a company’s annual meeting, the study offers that about 29% of the time companies granted stock options to directors on the same date as those given to executives.  Further, the study suggests that 3.8% of all grant events were super-lucky – defined as taking place at the lowest price of the calendar.

In this light, the study raises concerns about the role of outside directors as gate keepers in a company’s corporate governance structure.  As discussed by one of the study’s authors, Lucian A. Bebchuk, a Harvard Law School professor, this revelation has “large governance significance.”  To date the option scandal has focused on the agency problems between executives and the board of directors, while this study focuses on the agency problems between the outside directors and the company’s shareholders.  The concern becomes whether those expected and trusted to be gatekeepers have failed in their duties.  Perhaps its time to reevaluate these so-called watchdogs and carefully look at just who is watching the watchdogs.

See Bebchuk, Lucian Arye, Grinstein, Yaniv and Peyer, Urs C., “Lucky Directors” (12/2006). Available at SSRN: