Stock Option Expense: The Sword of Damocles Revealed

Abstract

Statement of Financial Accounting Standards (SFAS) No. 123 is one of the most controversial accounting standards ever issued by the Financial Accounting Standards Board (FASB 1995) (SFAS No. 123, para. 376). More than five years have passed since SFAS No. 123 first required firms to either recognize or disclose stock option expense based on the fair value of options granted. In light of the fractious debate surrounding its passage and ongoing differences of opinion regarding the usefulness of stock option expense data, this paper reports how the standard impacts firm performance. This study examines the effect of stock option expense on the diluted earnings per share and return on assets of 100 firms identified by Fortune magazine as “America's Fastest-Growing Companies.” We find that stock option expense has a material impact on the performance measures for a majority of our sample firms. Moreover, our analysis predicts stock option expense will grow over the next several years, potentially doubling in magnitude during that time. We also document some noncompliance with the disclosure requirements of SFAS No. 123, finding that 12 percent of the sample firms provided incomplete information during the most recent year examined.