The board formally grants the stock options to John every year at its January board meeting.This is important to note, because the grant date is what determines the exercise price on the options.
In our example, backdating the options is the same as giving Jane Doe a check for $35,000.
If the company does so without recording that $35,000 on the income statement as compensation, it understates its expenses and overstates its profits, which is a violation of generally accepted accounting principles (GAAP) and has been the grounds for a variety of fraud and miscellaneous charges from federal, state and local regulators.
Let's say Jane now decides to exercise her stock options.
On the day she decides to exercise her options, Company XYZ shares are trading at $50.
The practice sometimes also occurs in the insurance industry, whereby policy issuers make the effective date of a policy (or claim) earlier than the application date in order to obtain a lower premium for the customer (or obtain better claim results). When he was hired, the Company XYZ board of directors offered John an attractive salary as well as an annual grant of 1,000 Company XYZ stock options.