What is Bullet Dodging
Bullet dodging is a shady employee stock option granting practice, in which the granting of the options is delayed until a piece of really bad news involving the company has been made public and the stock's price falls. Because an option's exercise price is linked to the underlying stock's price when it is issued, waiting for the stock price to drop allows option holders to benefit from a lower exercise price.
BREAKING DOWN Bullet Dodging
Bullet dodging, like spring loading, which happens when options are granted just before the company reports really good news, is controversial. Some consider it to be a form of insider trading. And enabling employees to benefit from a lower exercise price — which increases their chances of making a profit — defeats the purpose of option-based compensation, which is meant to reward employees for helping to increase shareholder value. The option holder, who is usually a member of the company's management, is benefiting from potentially market-moving information that is not available to the public. However, while bullet dodging may be unethical, it is legal, as long as the board members who sign off on the options grant are informed in advance.
For example, suppose that XYZ Corp. had planned to grant stock options for its CEO on May 7, 2007. And suppose the company is going to fail to meet its earnings projections when they are published on May 14, and the share prices will likely fall as a result. Moving the option-granting date to May 15 is likely to lead to a lower exercise price than would be the case if the option were granted on May 7.
Other Shady Options Granting Practices
Another legal practice company’s use when granting stock options is to time the releases of bad news to precede regularly scheduled option grants. Numerous studies have shown that the stock prices of companies granting options tend to underperform the market in the days leading up to grants, and dramatically outperform afterward.
A fraudulent practice known as options backdating, where options are granted with a date prior to the actual issuances of the option, so the exercise price can be set at a lower price than that of the company's stock at the granting date - has become much more difficult after the Sarbanes-Oxley Act of 2002, made it a legal requirement for companies to report the granting of options to the Securities and Exchange Commission (SEC) within two business days.