Executive Stock Options: To Expense or Not?

Abstract

The issue of whether the stock option expense should be recognized when a company reports its earnings has produced an extended debate in virtually every segment of corporate America. Advocates of expensing argue that to obtain a more accurate picture of net earnings, this form of executive compensation, like other forms, must be deducted from earnings in the year the options are granted. Not to do so overstates corporate earnings and can lead to inflated stock prices. Moreover, not expensing encourages excessive option awards, which can distort managerial incentives, and can result in extreme forms of earnings management. Opponents counter that recognizing the expense requires an accurate and accepted measure of the value of options, which is controversial. Further, for many high tech companies, the present treatment encourages greater innovation and growth. Besides, the relevant information for calculating the impact on earnings is already disclosed in the footnotes to the financial statements. 1