Abstract
This article introduces new theories pertaining to optimal disclosure for equity-based incentives (EBI) in general and for incentive and compensatory Employee Stock Options (ESOs) in particular; within the context of competition. The article then develops the quantitative characteristics of optimal ESO disclosure (which can also be applied to other securities and disclosure problems), and explains why ESOs are neither debt nor equity, and should not be recorded in financial statements. The major finding is that the current methods of accounting for ESOs in the US, and the UK (and most developed countries) are not accurate or efficient, and will increase the propensity for fraud. ESOs present various problems in regulation, monitoring and enforcement which have not been addresses properly by existing legal and accounting systems. The current accounting rules for ESOs and incentive compensation are inadequate and need to be completely re-formulated.
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