scholarly journals Accounting For Employee Stock Options As Contingencies

2011 ◽  
Vol 10 (1) ◽  
pp. 19 ◽  
Author(s):  
Albert Y. Lew ◽  
Joseph F. Schirger
Keyword(s):  
Financial Reporting ◽  
Stock Options ◽  
Stock Option ◽  
Employee Stock Options ◽  
Accounting Profession ◽  
Accounting Practice ◽  
Accounting Principles ◽  
New Framework

<span>The accounting profession has long attempted to improve the disclosure of compensatory stock option information in financial reporting. While evidence of inconsistent practice has been publicized and acknowledged, suggestions for readjustment center largely around technicalities. The purpose of this article is to: (1) identify the inherent weakness of existing accounting principles on stock options, and (2) propose a new framework to account for employee stock options so that conflicting issues can be resolved in theory as well as in accounting practice.</span>

scholarly journals Diluted Earnings Per Share Overstatement Bias: Including Unrecognized Employee Compensation In Proceeds From Assumed Exercise Of Employee Stock Options Under The Treasury Stock Method

2013 ◽  
Vol 29 (6) ◽  
pp. 1657
Author(s):  
David T. Doran
Keyword(s):  
Financial Reporting ◽  
Stock Price ◽  
Stock Options ◽  
Fair Value ◽  
Stock Option ◽  
Employee Stock Options ◽  
Employee Compensation ◽  
Earnings Per Share ◽  
Service Period ◽  
Free Environment

Generally accepted accounting principles (GAAP) require firms to recognize compensation expense under the fair value method in the case of employee stock options. Straight line amortization of the options grant date fair value must be recognized as expense over the service period which decreases the earnings per share numerator. For diluted earnings per share (EPS), GAAP requires using the treasury stock method, where proceeds from assumed stock option exercise is used to purchase treasury shares at the average for the period price. Exercise proceeds include the exercise price plus unrecognized future employee compensation. For profitable firms, exercise is assumed if dilutive - more shares are assumed issued than are reacquired for the treasury which increases the diluted EPS denominator. These requirements are consistent across US GAAP and International Financial Reporting Standards. This paper tests whether including unrecognized employee compensation in proceeds from the assumed exercise of employee stock options under the treasury stock method is appropriate. A simple multi period model that assumes a risk free environment with complete certainty is applied. This study contributes to the literature by demonstrating that future unrecognized employee compensation should not be included in proceeds from the assumed exercise of stock options under the treasury stock method. Doing so consistently causes diluted EPS overstatement, and in certain instances causes assumed exercise of in the money options to be antidilutive, which results in complete exclusion from the diluted EPS calculation. This research extends the employee stock option work of Doran (2005 and 2008) that found: 1) Compensation expense recognized over the employee service period should equal the periodic annuity amount that provides the options grant date fair value, and 2) Treasury shares should be assumed purchased at the higher end of period stock price.

The Economic Dilution of Employee Stock Options: Diluted EPS for Valuation and Financial Reporting

2002 ◽  
Vol 77 (3) ◽  
pp. 627-652 ◽  
Author(s):  
John E. Core ◽  
Wayne R. Guay ◽  
S. P. Kothari
Keyword(s):  
Financial Reporting ◽  
Stock Price ◽  
Stock Options ◽  
Empirical Support ◽  
Stock Option ◽  
Employee Stock Options ◽  
Economic Implications ◽  
Employee Stock Option ◽  
The Difference ◽  
Biased Estimates

In this paper, we derive a measure of diluted EPS that incorporates the economic implications of the dilutive effects of employee stock options. We show that the existing FASB treasury-stock method of accounting for the dilutive effects of outstanding options systematically understates the options' dilutive effect, and thus overstates reported EPS. Using firm-wide data on 731 employee stock option plans, our proposed measure suggests that economic dilution from options is, on average, 100 percent greater than dilution in reported diluted EPS using the FASB treasury-stock method. We examine the implications of our analysis for stock price valuation, the price-earnings relation, and the return-earnings relation. We demonstrate analytically that when firms have options outstanding, empirical applications of equity valuation models that use reported per-share earnings as an input (e.g., Ohlson 1995) yield upwardly biased estimates of the market value of common stock. We predict that when the difference between our measure of economic dilution from options and the FASB treasury-stock method dilution from options is greater, the observed return-earnings and price-earnings coefficients will be smaller, and we provide some (albeit weak) empirical support for this prediction.

Discretion in Financial Reporting: The Voluntary Adoption of Fair Value Accounting for Employee Stock Options

2004 ◽  
Vol 18 (2) ◽  
pp. 97-108 ◽  
Author(s):  
Dahlia Robinson ◽  
Diane Burton
Keyword(s):  
Financial Reporting ◽  
Fair Value ◽  
Stock Option ◽  
Employee Stock Options ◽  
Market Returns ◽  
Employee Stock Option ◽  
Accounting Reports ◽  
Voluntary Adoption ◽  
The Impact ◽  
Is Value

This paper investigates the market reaction to announcements by firms of their decision to adopt the fair value provisions of SFAS No. 123 in accounting for their employee stock option (ESO) expense. Additionally, this paper examines ESO usage and expense of adopting firms and compares the impact of the expense on profitability measures for adopting firms relative to a matched set of control firms. We find a positive and significant abnormal return in the three days around the adoption announcements, suggesting that the decision to expense using the fair value method is value relevant. The positive abnormal announcement returns are mainly attributable to the earlier announcements, consistent with early announcements serving as a credible signal of a commitment to transparency in financial reporting. We find evidence that in the three years prior to the announcement year, adopting firms report significantly higher earnings than control firms yet fail to earn higher market returns, suggesting that adopters stand to benefit the most by improving the market's perception of their accounting reports. We also find that ESO usage, ESO expense, and the impact of ESO expense on profitability are significantly lower for adopters relative to control firms, although the impact of ESO expense is economically significant for 43 percent of the adopters.

Accounting for Employee Stock Options

2004 ◽  
Vol 18 (2) ◽  
pp. 135-156 ◽  
Author(s):  
Michael Kirschenheiter ◽  
Rohit Mathur ◽  
Jacob K. Thomas
Keyword(s):  
Stock Options ◽  
Financial Statements ◽  
Cash Flows ◽  
Stock Option ◽  
Share Price ◽  
Employee Stock Options ◽  
Deferred Taxes ◽  
Recommended Treatment ◽  
Option Values ◽  
The Common

Accounting for employee stock options is affected by whether outstanding options are viewed as equity or liabilities. The common perception is that the FASB's recommended treatment (per SFAS No. 123), which is based on the options-as-equity view, results in representative financial statements. We argue that this treatment distorts performance measures for three reasons. First, the deferred taxes associated with nonqualified options should also be included as equity, but are not. Second, since unexpected share price changes affect optionholders and equityholders differently, combining their interests provides an average earnings effect that is not representative for either group. We show that efforts to isolate the interests of common stockholders via diluted earning per share calculations (per SFAS No. 128) are inherently incapable of identifying wealth transfers between stockholders and optionholders. Finally, projections of future cash flow statements prepared under SFAS No. 95 overstate cash flows to current equityholders by the pretax value of projected option grants. We show that these distortions can be avoided simply by accounting for options as liabilities at grant and thereafter recognizing changes in option values (similar to the accounting for stock appreciation rights). Our analysis of stock option accounting leads to two, more general implications: (1) all securities other than common shares should be treated as liabilities, thereby simplifying the equity versus liability distinction, and (2) these liabilities should be recorded at fair values, thereby obviating the need to consider earnings dilution.

SFAS No. 123 Disclosures and Discounted Cash Flow Valuation

2000 ◽  
Vol 14 (2) ◽  
pp. 169-189 ◽  
Author(s):  
Leonard C. Soffer
Keyword(s):  
Cash Flow ◽  
Stock Options ◽  
Stock Option ◽  
Financial Statement ◽  
Employee Stock Options ◽  
Financial Statement Analysis ◽  
Discounted Cash Flow ◽  
Employee Stock Option ◽  
Valuation Technique ◽  
Discounted Cash Flow Valuation

One of the cornerstones of financial statement analysis is the discounted cash flow valuation. Despite the broad use of this valuation technique, and the economic importance of employee stock options to firm values, there is little guidance on how employee stock options should be incorporated in a valuation. This paper provides a comprehensive approach to doing so, including consideration of the income tax implications of option exercises, the simultaneity of equity and option valuation, and the use of the disclosures that were mandated recently by Statement of Financial Accounting Standards No. 123. The paper provides a comprehensive example using Microsoft's fiscal 1997 financial statements and employee stock option disclosure. This paper should be of interest to academics and practitioners involved in corporate valuation and financial statement analysis.

The Effect of FASB Statement No. 123R on Stock Repurchases: An Empirical Examination of Management Incentives

2017 ◽  
Vol 20 (02) ◽  
pp. 1750012 ◽  
Author(s):  
Steven Hegemann ◽  
Iuliana Ismailescu
Keyword(s):  
Stock Options ◽  
Stock Option ◽  
Stock Repurchases ◽  
Share Repurchases ◽  
Employee Stock Options ◽  
Empirical Examination ◽  
Negative Relation ◽  
Management Incentives ◽  
Reported Income

This study examines management’s response to the change in accounting for stock option-based compensation imposed by SFAS No. 123R, whose implementation is expected to reduce reported income. To cope with this impact, management may be motivated to decrease the use of stock options as part of compensating employees and engage in stock repurchases in an attempt to increase the value of outstanding employee stock options. Our findings demonstrate a significant negative relation between stock options granted and shares repurchased in the aftermath of SFAS No. 123R, particularly for the S&P 500 firms known for their heavy use of employee stock options. Furthermore, evidence of a contemporaneous increase in repurchases and leverage in the post SFAS 123R period may suggest that some of the buybacks may have been funded with debt. Our findings are robust to the inclusion of traditional determinants of share repurchases.

Dot.com or Dot.bomb? The Unpleasant Tax Surprise of Stock Options in a Volatile Market

2003 ◽  
Vol 18 (4) ◽  
pp. 385-395 ◽  
Author(s):  
Shelley C. Rhoades-Catanach
Keyword(s):  
Stock Market ◽  
Stock Options ◽  
Stock Option ◽  
Financial Impact ◽  
Employee Stock Options ◽  
Stock Market Crash ◽  
Employee Stock Option ◽  
Tax Deductions ◽  
Substantial Decline ◽  
Option Compensation

This case explores the tax treatment of employee stock options as well as associated tax- and financial-planning issues. The number of employee stock option plans and related option grants has increased dramatically in the last decade. Today, senior management and rank-and-file workers alike often own substantial numbers of options and shares of employer stock acquired through the exercise of options. While these holdings can be valuable forms of compensation, exercising options also can be costly and risky. Early in 2000, following the stock market boom and its substantial decline later that same year, many employees who exercised options while the equity markets were at record highs were left with large tax bills. In some cases, the taxes owed exceeded the value of the optioned stock at year-end. This case details the tax and financial impact of option exercise on one employee that chose to retain optioned stock during the stock market crash of 2000. The educational objectives of the case include: (1) becoming familiar with the tax and financial aspects of compensatory stock options, (2) identifying the risks and rewards of option grant and exercise, (3) quantifying the cash inflows and outflows associated with stock options and their tax consequences, and (4) planning to maximize the after-tax value of stock option compensation. The case also discusses the tax treatment of options from the employer's perspective and the policy issues associated with tax deductions for option exercise.

After the Stock Options Boom: Changes in Equity-Based Pay Following the Mandatory Adoption of IFRS 2

2021 ◽  
pp. 2150006
Author(s):  
Robert M. Gillenkirch ◽  
Olaf Korn ◽  
Alexander Merz
Keyword(s):  
Financial Reporting ◽  
Stock Options ◽  
The United States ◽  
Stock Option ◽  
Rent Extraction ◽  
Reporting Standard ◽  
International Financial Reporting Standard ◽  
Design Elements ◽  
Mandatory Adoption ◽  
Ifrs 2

This paper investigates the economic consequences of the mandatory adoption of International Financial Reporting Standard 2 (hereafter, “IFRS 2”) on firms’ choices between alternative executive compensation instruments. With a unique, hand-collected dataset that contains design elements of stock option plans, we find that the adoption of IFRS 2 affects both the decision to keep or to give up stock options and the choice of alternative equity compensation instruments. In contrast to recent evidence from the United States, we find that the majority of firms replacing stock options by other equity instruments switched to performance shares, not to restricted stock. Our dataset allows us to relate firms’ reactions to IFRS 2 to the three major rationales explaining stock option compensation practice, namely, optimal contracting, managerial rent extraction, and perceived cost. Our results suggest that all three rationales contribute to explaining changes in compensation design because firms with sophisticated option plans tend to keep their options, whereas design decisions by firms abandoning options are related to a lack of shareholder power.

scholarly journals A TOP-DOWN APPROACH FOR THE MULTIPLE EXERCISES AND VALUATION OF EMPLOYEE STOCK OPTIONS

2020 ◽  
Vol 23 (02) ◽  
pp. 2050004
Author(s):  
TIM LEUNG ◽  
YANG ZHOU
Keyword(s):  
Stock Options ◽  
Employee Stock Options ◽  
Top Down ◽  
Valuation Method ◽  
Cost Impact ◽  
Systems Of Pdes ◽  
The Cost ◽  
Job Termination ◽  
Over Time ◽  
New Framework

We propose a new framework to value employee stock options (ESOs) that capture multiple exercises of different quantities over time. We also model the ESO holder’s job termination risk and incorporate its impact on the payoffs of both vested and unvested ESOs. Numerical methods based on Fourier transform and finite differences are developed and implemented to solve the associated systems of PDEs. In addition, we introduce a new valuation method based on maturity randomization that yields analytic formulae for vested and unvested ESO costs. We examine the cost impact of job termination risk, exercise intensity and various contractual features.

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