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

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.

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Accrual management and the decision to sell or hold shares acquired from the exercise of employee stock options

Journal of Financial Reporting ◽

10.2308/jfr-2018-0002 ◽

2020 ◽

pp. 0000-0000

Author(s):

Thomas Smith ◽

G. Ryan Huston ◽

Richard M. Morton

Keyword(s):

Stock Option ◽

Employee Stock Options ◽

Short Term ◽

Post Exercise ◽

Employee Stock Option ◽

Holding Period ◽

Before And After ◽

Accrual Management ◽

The Impact

This study extends the employee stock option literature by examining the impact of accrual management, before and after stock option exercise, on the timing of sales of shares acquired at exercise. We find evidence that accrual management prior to exercise is positively associated with the decision to quickly sell shares after exercise, facilitating a short-term exercise-and-sell strategy. Alternatively, we find that, among executives initially choosing to hold at exercise, tax incentives appear to drive both post-exercise accrual management and the timing of sale transactions. Specifically, our results suggest that executives use income-increasing accruals during the holding period to bolster their stock option gains sand then sell immediately after satisfying the minimum (twelve month) holding period for long-term capital gain treatment. These results provide context for prior research that found evidence of earnings management leading up to option exercise on the expectation of an immediate sale.

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Congressional Intervention in the Standard-Setting Process: An Analysis of the Stock Option Accounting Reform Act of 2004

Accounting Horizons ◽

10.2308/acch.2007.21.1.1 ◽

2007 ◽

Vol 21 (1) ◽

pp. 1-22 ◽

Cited By ~ 30

Author(s):

David B. Farber ◽

Marilyn F. Johnson ◽

Kathy R. Petroni

Keyword(s):

Stock Options ◽

Political Action ◽

Fair Value ◽

Stock Option ◽

Financial Accounting Standards Board ◽

Employee Stock Option ◽

Setting Process ◽

Action Committee ◽

The Cost ◽

The Impact

We examine H.R. 3574, the Stock Option Accounting Reform Act of 2004 (the Act), which sought to prevent the Financial Accounting Standards Board (FASB) from requiring the expensing of employee stock options at fair value. We find that employee stock option expense under the Act would be approximately 2 percent of what it would be under the FASB's preferred method. We also find that House members supporting the Act were more likely to be Republican, to be conservative, and to have received larger Political Action Committee (PAC) contributions. Finally, the larger the impact of H.R. 3574 on the amount of stock option expense reported by the firm for employees who are not top-five executives, the more contributions the firm's PAC made to House members and to members of the committee that approved the Act. This result suggests that corporate opposition to the mandatory expensing of stock options at fair value is not driven solely by concerns of top-five executives about the cost of recognizing their own options.

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Accounting standards for employee stock option disclosure: The current debate

Corporate Ownership and Control ◽

10.22495/cocv4i3p8 ◽

2007 ◽

Vol 4 (3) ◽

pp. 87-95

Author(s):

Geoffrey Poitras

Keyword(s):

Accounting Standards ◽

Financial Statements ◽

Fair Value ◽

Stock Option ◽

Financial Accounting ◽

Current Debate ◽

Employee Stock Options ◽

Net Income ◽

Financial Accounting Standards Board ◽

Employee Stock Option

The paper examines the implications of recent changes to accounting standards for employee stock based compensation with contingent features. The Dec. 2005 implementation of FAS 123R by the Financial Accounting Standards Board requires the fair value of such expenses to be recorded in net income. The change is now impacting the reported financial statements of firms that have been substantial users of employee stock options. This provides an opportunity to directly assess the actual impact of FAS 123R on such firms. Arguments for and against mandatory expensing are reviewed and an assessment of the contrasting positions provided. Significant limitations of current reporting requirements are identified

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

Journal of Applied Business Research (JABR) ◽

10.19030/jabr.v29i6.8204 ◽

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.

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

The Accounting Review ◽

10.2308/accr.2002.77.3.627 ◽

2002 ◽

Vol 77 (3) ◽

pp. 627-652 ◽

Cited By ~ 61

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.

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The Value-Relevance Of Stock-Based Employee Compensation Disclosures

Journal of Applied Business Research (JABR) ◽

10.19030/jabr.v17i2.2077 ◽

2011 ◽

Vol 17 (2) ◽

Cited By ~ 8

Author(s):

Lynn Rees ◽

David M. Stott

Keyword(s):

Firm Value ◽

Stock Options ◽

Value Relevance ◽

Positive Association ◽

Fair Value ◽

Stock Option ◽

Business Community ◽

Employee Stock Options ◽

Employee Compensation ◽

Employee Stock Option

This study employs pro-forma company footnote disclosures to assess the value-relevance of employee stock option compensation expense using the fair value method as stipulated by Statement of Financial Accounting Standard No. 123.  The study is motivated by the controversy surrounding the issue of accounting for employee stock options and the countervailing effects of issuing stock options on firm value.  Although accounting regulators and the business community agree that employee stock options have value and therefore, are a form of compensation, critics of the FASB’s proposed fair value method of accounting for employee stock options argue that measuring the compensation expense using contemporary models will result in unreliable and meaningless measures.  Moreover, the expected future benefits from granting stock options suggest that this form of employee compensation is not a typical expense.  We find a significant association between the disclosed compensation expense using the fair value method and firm value that is in the opposite direction from other income statement expenses.  This result implies that the disclosed employee stock option expense is a value-relevant measure and the incentives derived from employee stock option plans provide value-increasing benefits to the firm.  In addition, we find the positive association between the employee stock option expense and firm value is greater for firms with more growth opportunities.

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SFAS No. 123 Disclosures and Discounted Cash Flow Valuation

Accounting Horizons ◽

10.2308/acch.2000.14.2.169 ◽

2000 ◽

Vol 14 (2) ◽

pp. 169-189 ◽

Cited By ~ 12

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.

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THE EFFECTS OF FIRM CHARACTERISTICS AND RECOGNITION POLICY ON EMPLOYEE STOCK OPTIONS PRICES AFTER CONTROLLING FOR SELF-SELECTION

Annals of Financial Economics ◽

10.1142/s201049521440003x ◽

2014 ◽

Vol 09 (02) ◽

pp. 1440003

Author(s):

CHII-SHYAN KUO ◽

SHIH-TI YU

Keyword(s):

Firm Value ◽

Threshold Model ◽

Stock Option ◽

Share Price ◽

Employee Stock Options ◽

Firm Characteristics ◽

Employee Stock Option ◽

Large Size ◽

Self Selection ◽

Recognition Rule

We examine whether and how firm characteristics, including firm size and liquidity, affect the relation between employee stock option (ESO) grants (as proxied by disclosed ESO expenses) and firm value. We also investigate how the implementation of a new share-based compensation recognition rule affects the pricing effect of ESOs. Prior studies have provided mixed results concerning how ESOs affect firm value. We argue that their findings could be attributable to self-selection and a non-uniform ESO-share price relation. We use the threshold model to address our research questions after controlling for self-selection bias. We find that markets tend to positively price ESOs in the case of firms characterized by large size and low liquidity. In addition, we find that after the new rule came into effect, ESOs became positively associated with firm value. These results are congruent with ownership and symbolic value theories, the lifecycle stages hypothesis and the contention that an ESO expensing policy enhances the quality of financial statements.

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DAMPAK STRUKTUR MODAL PADA SENSITIVITAS PENERAPAN KOMPENSASI OPSI SAHAM KARYAWAN TERHADAP KINERJA

EKUITAS (Jurnal Ekonomi dan Keuangan) ◽

10.24034/j25485024.y2010.v14.i1.2109 ◽

2017 ◽

Vol 14 (1) ◽

pp. 1

Author(s):

Nur Fadjrih Asyik

Keyword(s):

Firm Performance ◽

Capital Structure ◽

Stock Options ◽

Stock Option ◽

Company Performance ◽

Employee Stock Option ◽

Sensitivity Level ◽

The Impact ◽

Option Compensation ◽

Stock Option Compensation

This study aims to test whether the management that receive compensation in the form of stock options having an positive impact on company performance. This study considers the external performance measurement by identifying Cumulative Abnormal Return (CAR). In addition, this study aims to test whether the company's capital structure affects the sensitivity level of employee stock option compensation and firm performance. Capital structure is measured with debt to equity ratio. The result indicates that the proportion of Employee Stock Option Plan (ESOP) influence company performance in accordance with the predictions. This shows that the more stock options offered to employees then came a sense of belonging which resulted in more motivated managers to improve company performance. Furthermore, the higher the market performance of companies that can be achieved, the higher the profit (gain) will be obtained by the recipient of stock options. In addition, this study also shows that the impact of stock option grants at the company's performance declined with the greater capital structure of liability. This shows that the capital structure of liabilities will lower the sensitivity level of employee stock option compensation and firm performance. The higher the company's liabilities would reduce the rights of the owner of the dividends each period in accordance with the ownership of shares held since the company must take into account the interest costs to be paid to the creditor.

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The Impact of IFRS 2 "Share-Based Payment" on Malaysian Companies

Review of Pacific Basin Financial Markets and Policies ◽

10.1142/s0219091510002025 ◽

2010 ◽

Vol 13 (03) ◽

pp. 449-468 ◽

Cited By ~ 7

Author(s):

Ruhaya Atan ◽

Nur Syuhada Jasni ◽

Yousef Shahwan

Keyword(s):

Stock Options ◽

Negative Relationship ◽

Fair Value ◽

Employee Stock Options ◽

Accounting Standard ◽

Corporate Scandals ◽

Black Scholes ◽

Compensation Plan ◽

The Impact ◽

International Accounting Standard

In the wake of corporate scandals and excessive stock options compensation, International Accounting Standard Board (IASB) has introduced a new accounting standard, IIFRS 2 Share-based Payments. The scope of the standard extends beyond payments to employees, but for the purpose of this study, the focus is only on 'employee stock options'. IIFRS 2 requires a fair value of stock options records calculated on grant date, and recognized as compensation expenses over vesting periods. Prior to the introduction of IIFRS 2, stock options were not recognized and were only disclosed in the notes to the accounts. In Malaysia, the standard is mandatory for all companies listed on or after January 1, 2006. This study assumes the requirement existed in 2003. This study examines the impact of stock options expenses from 2003 to 2005, on the top 100 Malaysian companies. The three year observations show at least 24% of the sample exceeds the 5% materiality threshold on diluted EPS. The sectors that are impacted the most are the Trade/Service and Finance sectors. From the multiple-regression test, this study finds that fair value of stock options have a negative relationship with dividend yields (input of the Black-Scholes Merton (BSM) Model). Most companies in the sample are found to pay dividends and grant stock options at the same time. Therefore, this study suggests that companies need to restructure their compensation plan thus balancing the stock options granted and dividends paid in the future.

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