using PHP 5.2.14, this is what happens
[user@VE213 public_html]$ php -r "mkdir('directory', 0777);"
[user@VE213 public_html]$ ls -lt
drwxrwxr-x 2 rankranger rankranger 4096 Dec 8 17:28 directory
[user@VE213 public_html]$ php -r "chmod('directory', 0777);"
[user@VE213 public_html]$ ls -lt
drwxrwxrwx 2 rankranger rankranger 4096 Dec 8 17:28 directory
Did not find any related bugs in the php bug list, any idea?