What Is Bullet Dodging?
The term bullet dodging refers to an unethical employee stock options practice that delays the release of the options until a negative piece of news involving the company is made public, thus causing the stock's price to fall. 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.
- Bullet dodging is an employee stock options practice in which the options release is delayed until a negative press release comes out, causing the stock's price to drop and granting employees an optimal entry point.
- This process enables employees to benefit from a lower exercise price which increases their chances of making a profit.
- Options holders end up benefiting from potentially market-moving information not available to the public.
- Bullet dodging is a legal but controversial practice; some skeptics consider it a form of insider trading.
How Bullet Dodging Works
Employee stock options are a popular perk that some employers provide for their employees as part of their benefits packages. They are just another form of compensation that employees—executives and other employees—may receive along with their annual or hourly salaries. Although they are quite popular, instances of bullet dodging are often controversial and are considered by some to be a form of insider trading.
This process enables employees to benefit from a lower exercise price—the price where the underlying security can be bought or sold when put options or calls may be traded—which increases their chances of making a profit. This defeats the purpose of options-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, ends up benefiting from potentially market-moving information that is not available to the public.
Bullet dodging may be controversial, but it is legal as long as the board members who sign off on the options grant are informed in advance.
Bullet Dodging vs. Other Types of Controversial Employee Stock Option Practices
Bullet dodging isn't the only unethical practice companies have at their disposal when they grant stock options. Rather than move the date of the employee option around negative press releases, some companies specifically plan negative news to be released just prior to the set employee option date. Additional practices companies use include spring loading and backdating.
Spring loading, for example, is another similar controversial practice. It occurs when options are granted just before the company reports really good news—the opposite of bullet dodging. It allows employees to reap the benefits and profits from any good news that comes from a company. Just like bullet dodging, spring loading is also legal but considered controversial by some.
Another fraudulent practice is known as options backdating, in which 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. This 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.
Example of Bullet Dodging
Suppose that XYZ Corporation planned to grant stock options for its chief executive officer (CEO) on May 7, 2007. The company is aware it will fail to live up to its earnings forecasts when they are published on May 14, and the share prices will likely fall as a result. By moving the options-granting date to May 15, the CEO will likely be granted a lower exercise price than would be the case if the option were granted on May 7.