The Value-Relevance of Stock-Based Employee Compensation Disclosures

Abstract

This study employs pro-forma company footnote disclosures to assess the value-relevance of employee stock option compensation expense using the fair value method as stipulated by Statement of Financial Accounting Standard No. 123. The study is motivated by the controversy surrounding the issue of accounting for employee stock options and the countervailing effects of issuing stock options on firm value. Although accounting regulators and the business community agree that employee stock options have value and therefore, are a form of compensation, critics of the FASB's proposed fair value method of accounting for employee stock options argue that measuring the compensation expense using contemporary models will result in unreliable and meaningless measures. Moreover, the expected future benefits from granting stock options suggest that this form of employee compensation is not a typical expense. We find a significant association between the disclosed compensation expense using the fair value method and firm value that is in the opposite direction from other income statement expenses. This result implies that the disclosed employee stock option expense is a value-relevant measure and the incentives derived from employee stock option plans provide value-increasing benefits to the firm. In addition, we find the positive association between the employee stock option expense and firm value is greater for firms with more growth opportunities.