Option grant backdating investigations and capital market discipline

Using a large sample of option granting firms, some of which were investigated for option grant backdating, we develop a predictive model for such investigations and examine how the capital market responded as the backdating scandal unfolded. Firms that were investigated experienced significant stock price declines from the beginning of the Wall Street Journal's Perfect Payday series through the end of 2006. Firms predicted to have backdating problems, but not the subject of publicly revealed investigations, experienced stock price performance during the same period that was remarkably similar to that of firms with publicly revealed investigations. In contrast, firms not predicted to have backdating problems experienced normal stock price performance. Our results suggest that capital markets disciplined companies with suspicious option grant histories, often prior to, and irrespective of, any public revelation of an investigation into the matter.