Expense Employee Stock Options Research Articles

Why Did Politicians Intervene in the Fair Value Debate? The Role of Ideology and Special Interests

Politicians frequently intervene in the regulation of financial accounting. Evidence from the accounting literature shows that regulatory capture by special interests helps explain these interventions. However, many accounting rules have broad economic or social consequences, such as their effects on income distribution or private-sector subsidies. The perception of these consequences varies with a politician’s ideology. Therefore, if accounting rules produce those consequences, ideology plausibly spills over and explains a politician’s stance on the technical accounting issue, beyond special interest pressure. We use two prominent U.S. political debates about fair value accounting and the expensing of employee stock options to disentangle the role of ideology from special interest pressure. In both debates, ideology explains politicians’ involvement at exactly those points when the debate focuses on the economic consequences of accounting regulation (i.e., bank bailouts and top-management compensation). Once the debates focus on more technical issues, connections to special interests remain the most dominant force.

Why Do Politicians Intervene in Accounting Regulation? The Role of Ideology and Special Interests

ABSTRACTPoliticians frequently intervene in the regulation of financial accounting. Evidence from the accounting literature shows that regulatory capture by special interests helps explain these interventions. However, many accounting rules have broad economic or social consequences, such as their effects on income distribution or private sector subsidies. The perception of these consequences varies with a politician's ideology. Therefore, if accounting rules produce those consequences, ideology plausibly spills over and explains a politician's stance on the technical accounting issue, beyond special interest pressure. We use two prominent U.S. political debates about fair value accounting and the expensing of employee stock options to disentangle the role of ideology from special interest pressure. In both debates, ideology explains politicians’ involvement at exactly those points when the debate focuses on the economic consequences of accounting regulation (i.e., bank bailouts and top management compensation). Once the debates focus on more technical issues, connections to special interests remain the dominant force.

Lobbying and Opposition to SFAS No. 123(R): An Examination of Campaign Contributions from CEOs and PACs

SYNOPSISWe examine the contributions of CEOs and company-affiliated political action committees (PACs) to members of Congress who supported a moratorium on the Financial Accounting Standards Board's 2003 proposed standard to require firms to expense stock-based compensation at fair value. Our evidence—based on a sample of firms targeted by shareholder proposals to voluntarily expense employee stock options—indicates that CEOs and PACs had different motivations for lobbying on this policy issue. Specifically, we find that opposition to shareholder proposals varies positively with CEOs' contributions to the moratorium co-sponsors. However, opposition varies positively with PAC contributions to co-sponsors only when the targeted CEO contributes to the PAC. These results suggest that CEO lobbying relates more to executives' interests to preserve excessive pay, whereas PAC lobbying relates more to interests in preserving the level of earnings.

Cash Holding in U.S. Firms: Evidence from FAS 123R

Using exogenous variation in CEO stock option grants generated by FAS 123R which mandated expensing of employee stock options, we investigate the causal effects of CEO risk incentives (vega) on cash policies of U.S. firms. Employing a difference-in-difference framework, in which we identify firms most affected by the regulatory change, we find no evidence that changes in CEO portfolio vega lead to significant changes in corporate cash holdings and the marginal value of cash. Our evidence challenges the view that option-based compensation is a first-order driver of corporate cash policy and instead implies that previously documented associations perhaps reflect endogeneity rather than a causal influence.

Managing Employee Stock Option Expense: A Fair Value Approach

Owing to special characteristics, classic option pricing models are not well suited to the valuation of employee stock options (ESOs). This paper attempts to conduct a more general fair value estimation based on attaching performance targets to option vesting. Considering a setting that includes factors such as options that may be exercised early at employee discretion, employee exit rates and firm default risk, this paper presents a sensitivity analysis and empirical tests of option value. The results highlight the importance of considering the characteristics of ESOs in the design of performance‐vested option plans so as to provide the most attractive incentives for employees.

Are CEOs Held Accountable for Unrecognized Expenses? The Case of Implied Employee Option Expense

An extensive body of research has investigated whether CEOs are held accountable for various earnings components by testing the sensitivity of CEO cash compensation to these earnings components. No study, however, has examined whether CEOs are held accountable for expenses unrecognized in earnings. This study investigates whether CEOs were held accountable for fair value employee stock option (ESO) expense in the period 1996-2005, during which the expense was not recognized, but rather implied by pro forma earnings disclosed in the footnotes under SFAS No. 123. Controlling for CEO stock option grants and other variables, I find that CEO cash compensation decreased with implied fair value ESO expense in the second half of the period 1996-2005 but not in the first half. The result represents the first evidence that CEOs can be held accountable for unrecognized expenses and how boards of directors view an unrecognized expense may be influenced by public opinions (accounting for fair value ESO expense was hotly debated in late 1990s and early 2000s). In high-tech industries, however, the result is very different. In these industries, CEO cash compensation was related to fair value ESO expense in neither the first half nor the second half of the period 1996-2005. The result is unsurprising given the strong position taken publicly by high-tech industry leaders that fair value ESO expense is not an expense to the firm and cannot be measured accurately.

THE EFFECTS OF FIRM CHARACTERISTICS AND RECOGNITION POLICY ON EMPLOYEE STOCK OPTIONS PRICES AFTER CONTROLLING FOR SELF-SELECTION

We examine whether and how firm characteristics, including firm size and liquidity, affect the relation between employee stock option (ESO) grants (as proxied by disclosed ESO expenses) and firm value. We also investigate how the implementation of a new share-based compensation recognition rule affects the pricing effect of ESOs. Prior studies have provided mixed results concerning how ESOs affect firm value. We argue that their findings could be attributable to self-selection and a non-uniform ESO-share price relation. We use the threshold model to address our research questions after controlling for self-selection bias. We find that markets tend to positively price ESOs in the case of firms characterized by large size and low liquidity. In addition, we find that after the new rule came into effect, ESOs became positively associated with firm value. These results are congruent with ownership and symbolic value theories, the lifecycle stages hypothesis and the contention that an ESO expensing policy enhances the quality of financial statements.

Why Do Managers Oppose the Fair Value Expensing of Employee Stock Options?

Why Do Managers Oppose the Fair Value Expensing of Employee Stock Options?

Firm Characteristics, Recognition Policy and Pricing of Employee Stock Option

We examine whether and how firm characteristics, including firm size and liquidity and the implementation of a new share-based compensation recognition rule affect the relation between the employee stock option (ESO) grants (as proxied by the disclosed ESO expenses) and firm value. Prior studies provide mixed results concerning how ESOs affect firm value. We argue their findings could be attributable to self-selection and a non-uniform ESO-share price relation. We use the threshold model to address our research questions after controlling for self-selection bias. We find that markets tend to positively price ESOs for firms of large size and those with low liquidity. In addition, we find that after the new rule came into effect, ESOs became positively associated with firm value. These results are congruent with the ownership and symbolic value theory, lifecycle stages hypothesis and the contention that the ESO expensing policy enhances the quality of financial statements.

The non-uniform pricing effect of employee stock options using quantile regression

Issuing employee stock options (ESOs) transfers equity claims from current stockholders to employees, and thereby dilutes existing shareholder interests. Because employees are motivated to exert additional effort toward better performance, the value of transferred ownership claims proxied by ESO expense represents a cost of generating firm value. There are several econometric issues, most notably including the fact that the disclosed ESO expense is an endogenous variable. Without controlling for the simultaneity problem, inferences based on results from OLS analyses may be misleading. More importantly, a considerable amount of ESO expense data is censored at zero. Such a censoring problem can make the population distribution severely skewed, resulting in estimation bias. Therefore, we need to take into account the censored data issue. No prior studies have considered these two issues simultaneously. Failure to control for both censoring problem and endogeneity could explain the inconsistent results documented in prior studies. In this paper, we use the two-stage quantile regression (QR) proposed by Amemiya (1982) and Powell (1983) to examine possible nonlinear relationships, especially whether conditionally higher-stock price (or better performing) firms show a stronger negative pricing effect of ESO expense (that is, the relation between ESO expense and share price) than conditionally lower-share price firms. Our results suggest that the linear regression model greatly underestimates this negative pricing effect at higher quantiles, so the nonlinear relationship is obscure when using the standard linear model. We also consider alternative interpretations as to why heterogeneity exists in the pricing effect of ESO expense and assess whether our results concur with these explanations.

Incentive Compensation and ESO Expensing Under SFAS No. 123 and 123(R)

In December 2004, FASB issued a revised SFAS No. 123, Share-Based Payment, and required public companies to expense employee stock options (ESOs). Top executives at major corporations strongly opposed ESO expensing, citing many conceptual and implementation issues. They argue, for example, ESOs are a private arrangement between employees and shareholders and the related expense does not constitute an expense to the firm. They also argue the models that FASB recommends to calculate the fair values of ESOs, such as Black and Scholes and binomial models, are unsuitable for ESOs. This study finds that annual CEO cash compensation is negatively associated with ESO expense in the period 1996-2005, the only period for which ESO expense was publicly available for many firms and also a period in which ESO expense was disclosed but not recognized. If disclosed ESO expense affects CEO compensation, recognized ESO expense is likely to not only do so but do so to a greater extent. Our result therefore provides an alternative explanation for why firms oppose fair value ESO expensing. The result also makes it less likely that managers opposed fair value ESO expensing primarily because of conceptual and measurement issues, notwithstanding their public statements to the contrary.

Unconditional and Conditional Conservatisms’ Relationship to Firms’ Voluntarily Expensing of Employee Stock Options

Unconditional and Conditional Conservatisms’ Relationship to Firms’ Voluntarily Expensing of Employee Stock Options

Market-to-book ratio and conditional conservatism: firms’ voluntary expensing of employee stock options

Purpose – This paper aims to examine the relationship between firms’ decisions to expense employee stock options (ESOs) under the voluntary period of Statement of Financial Accounting Standard No. 123 (SFAS 123) and their market-to-book (MTB-1) ratio and conditional conservatism. Conservatism is chosen because, even though expensing of ESOs is a conservative accounting treatment, it is not obvious how the decision would be related to the MTB-1 ratio and conditional conservatism, particularly because the MTB-1 is a long-run measure of conservatism and the decision to voluntarily expense is examined over two years. The setting provides a unique opportunity to assess how two major proxies of conservatism are related. Design/methodology/approach – Using firms listed in the S&P 1500 index, firms that expensed ESOs are compared to firms that disclosed only in the financial statements. The main comparison uses a logistic regression. Findings – During the period when expensing ESOs was voluntary, SFAS 123, the MTB-1 ratio was negatively associated with ESO expense recognition, but conditional conservatism was positively associated with ESO expense recognition. The former is attributed to incentives of conservatism and the latter to the tenet of conservatism tending to reduce income. Research limitations/implications – The findings add to the literature/controversy on the negative relationship between the MTB-1 ratio and conditional conservatism. More important, they support using more than one measure of conservatism in studies that involve accounting conservatism. A limitation is that the findings are specific to voluntary ESO expense recognition. Originality/value – This is the first study to examine how conservatism affects the choice to recognize an item on the financial statements or disclosure only. In addition, the study shows that firms were willing to incur real costs from their financial reporting.

A censored quantile regression analysis of employee stock options substitution for debt and the impact of SFAS 123R

PurposeThis paper aims to examine whether the substitution of employee stock options (ESOs) for debt occurs for firms with different tax status classifications throughout the conditional distribution of interest expense before and after the implementation of Statement of Financial Accounting Standard 123R (SFAS 123R).Design/methodology/approachThis study uses Censored Quantile Regression (CQR) to assess whether the substitution effect is dependent on firms' position in the conditional distribution of interest expense. Our sample firms are categorized into two groups: one group (tax‐sensitive) that is sensitive to additional deductions due to a moderate income level and the other group (tax‐insatiable) that is not sensitive because of very high income level.FindingsThe substitution effect is not present for firms with below medium level of interest expense. Only tax‐sensitive firms substitute at medium levels of interest expense while both tax‐sensitive and tax‐insatiable firms substitute at high levels of interest expense. Tax‐insatiable firms with very high levels of interest expense also substitute; however, tax‐sensitive firms with very high levels of interest expense only substitute after SFAS 123R required firms to report ESO expense in financial statements. We attribute the substitution patterns revealed by the CQR analysis to a positive relationship between interest expense and cost of debt.Originality/valueTo the authors' knowledge, this is the first paper to analyze firms' tax status classification impact on the substitution of ESO expense for interest expense across different levels of interest expense. Our application of CQR should benefit researchers who are interested in examining explanatory variables' impact at various points in the conditional distribution of the dependent variable. This study also refines the conjecture that ESOs are substitutes for debt by demonstrating that such relationship is dependent on the level of interest expense and tax status. Furthermore, the finding of firms substituting ESOs for debt provides accounting standard setters a reason to begin requiring firms to re‐measure the value of ESOs after the grant date until the exercise date.

Mandated Recognition of Employee Stock Option Expense - The Case of Canada

On December 18, 2003 the Accounting Standards Board of Canada announced that all firms registered in Canada would be required to expense stock options-based compensation effective January 1, 2004. While a few firms had voluntarily opted to expense stock options prior to this date, the vast majority of firms had not. This study investigates the market reaction to this announcement by listed firms in the Toronto Stock Exchange that continued to disclose option expense rather than report it in the financial statement. We find no average market reaction by our sample firms affected by this mandate around the announcement date, but a significantly negative market reaction during the 5-day window around the issuance date of the exposure draft. However, in cross-sectional tests around the mandated expense announcement date, we find a significant negative relationship between the cumulative abnormal returns and the Black–Scholes value (and number) of options outstanding and of options granted the previous year. These results suggest that the magnitude of the market reaction to the mandated expense announcement is related to the firm's usage of options. Our results provide further evidence that stock prices may not fully impound information disclosed in footnotes.

Employee Decision-Making and Expensing of Employee Stock Options

Employee Decision-Making and Expensing of Employee Stock Options

Pricing of employee stock options: marketability does matter

Portfolio managers are rightly concerned about the marketability of the investments they include in their portfolios. Equity portfolio managers are also interested in how firms estimate the cost of the stock options they pay their employees. A recent attempt to develop market pricing of employee stock options (ESOs) illustrates the discount in price, and understatement of ESO expense, that will result when a financial instrument has little or no marketability. This paper investigates the auction pricing of an ESO tracking security called ESOARS and furnishes evidence of auction underpricing amounting to at least 25% in each auction. The paper shows that the underpricing can be largely explained when discounts for lack of marketability based on published marketability discount models are applied to ESO prices from well-accepted ESO valuation models. It quantifies how much lack of marketability can adversely affect a security’s price.

No More Scandals: A Simple Model For Valuing Employee Stock Options

<p class="MsoNormal" style="text-align: justify; margin: 0in 34.2pt 0pt 0.5in;"><span style="font-size: 10pt;"><span style="font-family: Times New Roman;">The escalating size of compensation packages to senior managers and investor disillusionment have resulted in growing calls for the expensing of employee stock options (ESO).<span style="mso-spacerun: yes;">  </span>While initially slow to respond, the FASB has now mandated the expensing of ESO.<span style="mso-spacerun: yes;">  </span>The two primary methods used to value ESO, the Black-Scholes closed form equation and the lattice model, suffer from several deficiencies<span style="mso-spacerun: yes;">  </span>.A Simple model for valuing ESO that marks the option expense to market in succeeding financial statement dates and allows for the staggered exercise dates of option holders is available. The model is easy to understand, would have a low cost of implementation, and offers a superior estimate of the true cash flow effects associated with the opportunity cost to shareholders of ESO exercise.</span></span></p>

The Value-Relevance Of Stock-Based Employee Compensation Disclosures

<p class="MsoNormal" style="text-align: justify; margin: 0in 37.8pt 0pt 0.5in;"><span style="mso-bidi-font-style: italic;"><span style="font-size: x-small;"><span style="font-family: Batang;">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.<span style="mso-spacerun: yes;">  </span>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.<span style="mso-spacerun: yes;">  </span>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.<span style="mso-spacerun: yes;">  </span>Moreover, the expected future benefits from granting stock options suggest that this form of employee compensation is not a typical expense.<span style="mso-spacerun: yes;">  </span>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.<span style="mso-spacerun: yes;">  </span>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.<span style="mso-spacerun: yes;">  </span>In addition, we find the positive association between the employee stock option expense and firm value is greater for firms with more growth opportunities.</span></span></span></p>

GAAP/Tax Differences In Accounting For Nonqualified Employee Stock Options: The Gathering Storm

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-size: 10pt;"><span style="font-family: Times New Roman;">The escalating size of compensation packages to senior managers and investor disillusionment resulted in the issuance of FAS 123(R). Under the current rules, the grant date fair value of employee stock options (ESO) are expensed over the vesting period. The two primary methods used to value ESO are the Black-Scholes closed form equation and the lattice model. Several studies suggested an alternative Simple model for valuing ESO that marks the option expense to market in succeeding financial statement dates and allows for the staggered exercise dates of option holders. This approach is easy to understand, would have a low cost of implementation, and offers a superior estimate of the true cash flow effects and economic injury associated with the opportunity cost to shareholders of ESO exercise. Moreover, the Simple model would head off another threat to the legitimacy of the FASB that is unfolding in the U.S. Congress as Senator Carl Levin holds hearings on ESO in the Senate Permanent Subcommittee on Investigations to decide what to do about the multi-billion dollar gap between what companies report to stockholders as ESO expense and what they deduct on their tax returns. In addition, this gap results in highly controversial rules of accounting and reporting for the favorable impact of the deductions in the financial statements.</span></span></p>