Options Reporting and the Political Costs of CEO Pay

Abstract

Managers' systematic influence on accounting policy is well documented in the earnings management literature. Recent studies in the “management of information” line of research suggest that such influence is exhibited in financial reporting more generally, including supplemental disclosures in proxy statements. Using 1996 compensation data, I extend recent research on how firms report the value of options paid to their CEOs. I conduct several tests of the argument that potential political costs of unexplained compensation explain cross-sectional variation in how aggressively firms report option awards. Even after incorporating several variables not considered previously, I find strong support for the assertion that firms whose CEOs receive unexplained pay relative to performance tend to report lower grant date values for their CEOs' option awards. The evidence also suggests that the tendency to report lower grant date values is stronger for firms under more scrutiny from institutional owners. Contrary to previous research, I find that unexplained pay also increases the likelihood that the firm will choose grant date reporting methods (over the allowable alternative) in their proxy disclosures. I interpret the overall results as consistent with the argument that political costs related to compensation influence options reporting. The findings have implications for accounting standard-setters and for researchers who rely on estimates of option values reported in proxy statements.