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Stock options are promoted by their supporters as the most effective way to align executive and employee interests with those of shareholders.
They are supposed to transform executives from fly-by-night plunderers in the mold of former Tyco or World Com executives into rational leaders who make prudent, long-term-oriented decisions with shareholder capital.
The exercise price of an option is crucial because it is the price the executive or employee option holder must pay to the company when exercising options in return for newly issued shares.
Simply put, backdating a stock option grant amounts to ripping off shareholders by shortchanging the company treasury.
Shares are issued to option holders at artificially low prices and the company gets an artificially low amount of capital in return for its shares.
This practice requires at least a nominal investment on the part of the option holder if he or she wishes to exercise.
The CEO’s conflict of interest between short-term personal wealth maximization and long-term shareholder interests tends to tilt in the shareholders’ favor.