Why Do Firms Use Non-Executive Stock Option Plans: Evidence from FAS 123R

Abstract

We study whether non-executive stock option plans are used to provide incentives and retention motivations by exploiting FAS 123R. FAS 123R mandates that all firms expense stock-based compensation at fair value on the income statement. The adoption of FAS 123R represents an exogenous change in the accounting benefit while leaving any economic benefits and costs of options intact. Our results do not support the hypothesis that non-executive stock options are used to provide incentives and retention motivations. Specifically, we find that all firms substantially decrease their use of stock options and this decline is strongly correlated with a proxy for the accounting effect of option expensing. Further, the decline in option use does not have any significant effects on firm performance and employee behavior. Overall, the empirical evidence surrounding FAS 123R introduction indicates that accounting benefits of reporting higher income were a major contributor to non-executive option use, if not the only one.