Market Valuation of Stock Option Compensation: Changes in Sentiment or Reporting?

Abstract

This study examines whether market valuation of stock option compensation has changed as the accounting for stock option compensation moved from footnote disclosure to income statement recognition. We also examine whether market sentiment for stock options shifted following the financial scandals of 2001-2002. Using a market returns model, we find that the market initially valued stock option compensation positively, suggesting that stock option grants provide a net accretive effect on firm value. However, investor sentiment towards option compensation turned significantly negative in the period after 2001. Further, although prior studies document that there was a positive abnormal return at the time firms first announced their decision to voluntarily recognize option expense, this benefit may have proved short-lived as the market reacts negatively to options compensation once included in income.