Determining fair values of performance‐vested and forfeiture‐embedded employee stock options

This study provides a new approach to determine the fair value of ESOs by extending the performance‐vested option pricing model. The model developed in this study takes both vesting period and forfeiture rate into consideration to capture characteristics of ESOs. Empirical and sensitivity analyses give evidence for the importance of these two elements. Empirical results also support that the derived model can be employed to increase the accuracy of ESOs’ fair value.     

The association between employee stock option disclosures and corporate governance: Evidence from an enhanced disclosure regime

This study examines the role of corporate governance in employee stock option (ESO) disclosures following the revision of AASB 1028 Employee Benefits in 2001. We find that, while firms do not fully comply with AASB 1028 ESO disclosures, they voluntarily provide other ESO disclosures. In relation to corporate governance measures that have a role in the financial reporting process, we find two corporate governance measures dominate our results—the quality of auditor and duality of the role of CEO and Chair of the Board of Directors. We show that, in general, external auditor quality has positive incremental association with both mandatory and voluntary ESO disclosures while the dual role of CEO and chairperson of the board is associated with lower levels of mandatory disclosure.     

The option to quit: The effect of employee stock options on turnover

We show that in the years following a large broad-based employee stock option (BBSO) grant, employee turnover falls at the granting firm. We find evidence consistent with a causal relation by exploiting unexpected changes in the value of unvested options. A large fraction of the reduction in turnover appears to be temporary with turnover increasing in the third year following the year of the adoption of the BBSO plan. The increase three years post-grant is equal in magnitude to the cumulative decrease in turnover over the three prior years, suggesting that long-vesting BBSO plans delay, instead of prevent, turnover.     

Non-marketability and the value of employee stock options

We adapt the Benninga et al. (2005) framework to value employee stock options (ESOs). The model quantifies non-diversification effects, is computationally simple, and provides an endogenous explanation of ESO early-exercise. Using a proprietary dataset of ESO exercise events we measure the non-marketability ESO discount. We find that the ESO value on the grant date is approximately 45% of a similar plain vanilla Black–Scholes value. The model is aligned with empirical findings of ESOs, gives an exercise boundary of ESOs and can serve as an approximation to the fair value estimation of share-based employee and executive compensation. Using the model we give a numerical measure of non-diversification in an imperfect market.     

Disclosure and liquidity management: Evidence from regulation fair disclosure

We examine the effect of the firm’s information environment on its liquidity policy by exploiting a natural experiment involving Regulation Fair Disclosure (Regulation FD). We find, on average, Regulation FD has a negative impact on firm cash holdings. We also directly evaluate changes in firm disclosure policy and find the negative Regulation FD-cash holdings relation is stronger for firms that increased public disclosure and holds largely for firms that faced lower proprietary costs of public disclosure. Furthermore, we find this negative relation is more pronounced for firms with limited access to the credit market. We capture the medium-term effect of Regulation FD two years before and two years after the implementation. Overall, our results suggest that the change in the amount of information disclosed in response to Regulation FD, an externality effect, affects information asymmetry between firms and outside investors and thus cash holdings.     

The association between financially expert independent directors and the accounting for employee stock options

This study investigates how the financial expertise of independent directors is associated with voluntary accounting policy decisions. As representatives of a company’s shareholders, financially-expert independent directors are more likely to cause management to pursue higher quality accounting policy decisions. The policy decision investigated involves the expense/non-expense policy choice for employee stock options as previously permitted under SFAS No. 123. Using a sample of 174 option-expensing firms and a matched control sample of 174 non-expensing firms, the results indicate a significant, positive association between the decision to expense employee stock options and the financial expertise of a company’s independent directors. Further, a significant, negative association was found between the option-expensing decision and whether the chief executive officer was the largest internal blockholder.     

Making imaginary worlds real: The case of expensing employee stock options

West [West, B. (2003). Professionalism and accounting rules. London: Routledge] and Chambers [Chambers, R. J. (1966). Accounting evaluation and economic behavior. Houston: Scholars Book Company] have provocatively argued that financial reporting has reached a state of near-total incoherence. In this paper, we argue that a source of this incoherence is the transformation of the US accounting academy into a sub-discipline of financial economics, a transformation in which accounting became a servant of the imaginary world of neoclassical economics. After noting the unusually prominent role of rules within the accounting profession, we describe the displacement of accounting’s centuries-old root metaphor of accountability by the metaphor of information usefulness, and situate that displacement within neoliberalism, a broader political movement that arose after World War II. Finally, we use SFAS 123R, the recently issued stock option standard, as a case study of the incoherence that West and Chambers assert. Through various issues – such as reflexivity, theory paradox, and unexplained questions of responsibility – we demonstrate the logical inconsistencies involved in SFAS 123F. The incoherence of stock option reporting rules raises serious questions about the information metaphor as a foundation for either individual rules or the standard setting process. The Financial Accounting Standards Board’s (FASB) attempts to make the imaginary world of neoclassical economics real have resulted in rules which are not defensible.     

Taxation and executive compensation: Evidence from stock options

Understanding the effects of taxes on executive compensation provides insight into the process determining this compensation and is a key input to top income tax rate policy. A 2010 tax reform in Canada, which greatly increased the effective tax rate on stock option compensation for a subset of firms, provides a natural experiment with which to address this issue. Difference-in-differences estimates suggest that this tax increase resulted in an immediate reduction in both stock option grants and the fraction of total compensation made up of stock options with limited, if any, substitution towards other components of compensation.     

Disclosure versus recognition: the case of expensing stock options

The SFAS 123R comment process generated over 6,500 comment letters, most of which were against the standard’s enactment. This outpouring of emotion indicates that many believe that disclosure versus recognition matters. Our paper provides evidence for the debate whether managers’ discretion, motivation, and accuracy of stock option estimates differ under the recognition and disclosure reporting regimes. We compare firms that are mandatorily forced to recognize stock options expense with those voluntarily choosing to do so. First we find that mandatory firms (versus voluntary) with more intensive stock option granting tend to understate option estimates, especially in the post SFAS123R period. Our results suggest that a higher recognition cost motivates firms for doing so. Second, we find that mandatory firms with lower future operating risk have better accuracy in the post SFAS123R period, as compared to themselves in the pre SFAS123R period and voluntary firms in the post SFAS123 period. Our results support the notion that the informativeness of option estimates explains the level of accuracy. The findings of this paper add to the debate on the benefits of recognizing stock option expenses.     

Causes and effects of employee stock option plans: Evidence from Singapore

This study highlights the determinants for the adoption of employee stock option plans (ESOPs) in Singapore and measures the impact of ESOP announcements on the shareholder wealth of adopting companies. We find that ESOP value is positively associated with a firm's growth opportunities but negatively related to interest coverage. Although larger firms are more likely to adopt ESOPs relative to smaller ones, among those that use ESOPs, the larger firms tend to use less ESOPs than the smaller ones. A further investigation of the market response to the adoption of ESOPs shows that the stock price reacts positively to such announcements, suggesting that investors view ESOPs favorably. The evidence demonstrates that ESOPs tend to align managerial with shareholder interests and contribute to the improvement of company performance.     

The effects of information disclosure regulation on stock markets: Evidence from Vietnam

This paper investigates the effects of regulation pertaining to information disclosure on the Vietnam stock market. Using the event study methodology, we examine sectoral reactions, in terms of risk and return, following the announcements on information disclosure regulation in Vietnam. To validate the results, we also conduct several robustness tests such as the removal of firm-specific information and the use of a wide variety of ARCH models such as GARCH (1,1). We find evidence indicating that when the market anticipates a piece of regulation on information disclosure, most sectors experience negative reactions two and five days before the first announcement. Positive reactions are observed on the event date, as well as two and five days afterwards. Furthermore, we document a difference between the Ho Chi Minh Stock Exchange (HOSE) and the Hanoi Stock Exchange (HNX) in terms of market reaction. The results also show that the sectors experience changes in short-term systematic risk. Our contributions to the literature are threefold. First, we focus on a complete and more updated set of the Vietnam stock market’s information disclosure regulation. Second, our study examines the effects of a series of events on a single regulation at sectoral and firm levels in an emerging market. Third, in addition to sectoral analysis, we analyse the Vietnam stock market reaction at the firm level.     

Employee relations and stock price crash risk: Evidence from employee lawsuits

In this paper, we examine the effect of firms' employee relations, measured by the number of employee lawsuits divided by the total number of employees, on stock price crash risk. Firms with higher employee lawsuit ratios tend to have higher stock price crash risk. Our results are robust after addressing possible endogeneity and using alternative measures of employee relations and stock price crash risk. We also find that the association between the employee lawsuit ratio and stock price crash risk is less prominent for state-owned enterprises, for firms with stringent external monitoring, and for firms with positive earnings news. Finally, earnings aggressiveness appears to be the channel through which the employee lawsuit ratio affects stock price crash risk. Collectively, our study is in line with the stakeholder theory, and highlights the importance of employee lawsuit for preventing crash of stock price.     

Exercise behavior,valuation, and the incentive effects of employee stock options

We use a large database on ESO exercises to document characteristics of exercise behavior and calibrate a utility-based model for measuring how differences in exercise behavior are manifested in option values and incentives. Option values and incentives computed from the model calibrations are compared to those computed from models used to value tradable options. Our analysis provides guidance to both academics and practitioners about how differences in exercise behavior and model choice affect measures of ESO values and incentives, and underscores the importance of gaining a thorough understanding of the underlying economic forces that affect the behavior of ESO holders.     

Accounting disclosure and firms' financial attributes: Evidence from the UK stock market

This paper focuses on the disclosure of accounting information in the financial statements of UK firms. The primary objective of the study is to analyse the financial characteristics of firms that provide extensive disclosures, and assess the financial impact of their motives, such as for example the need to raise equity finance. The study examines the financial attributes of firms that disclose information about key accounting issues including risk exposure, changes in accounting policies, use of international financial reporting standards and hedging practices. Firms are inclined to disclose accounting information in order to assure the market participants that their accounting policies are consistent with the accounting regulation and meet the information needs of their stakeholders. The study shows that in order to raise finance in the capital and debt markets, firms tend to provide extensive accounting disclosures. Firms that provide informative accounting disclosures appear to display higher size, growth and leverage measures. The findings also show that the disclosure of sensitive accounting information has not adversely affected firms' profitability. In fact, firms that provide detailed accounting disclosures tend to exhibit higher profitability. The implementation of international financial reporting standards enhances the quality and the comparability of financial statements; hence it promotes consistency and reliability in financial reporting and facilitates companies in raising capital internationally.     

Financial disclosure,investor protection and stock market behavior: an international comparison

The main purpose of this study is to examine the relationship between financial opacity, investor protection and stock market behavior for sixteen countries. We use the 1995 CIFAR corporate disclosure ratings and the 2006 World Bank investor protection index to measure a country’s relative level of financial transparency and legal protection for investors. The return behavior of each country is examined using numerous time series tests such as serial correlation, Markov chain, runs, duration dependence and variance ratio tests. We found that the results show no significant differences between high and low disclosure countries. However, high disclosure countries appear to be associated with a lower level of stock market volatility. Cox proportional hazard test results indicate that extreme returns (positive and negative) are more likely in low disclosure countries.     

The role of tax regulation and compensation contracts in the decision to voluntarily expense employee stock options

We show that firms with executive bonuses that qualify for deduction under Internal Revenue Code Section 162(m) were less likely to expense stock option compensation (SOC) in 2002. Additionally, the more likely it is that a qualified firm will incur re-contracting costs, the less likely it is that the firm will expense SOC. CEOs of qualified firms that also expense SOC receive smaller bonuses than CEOs of expensing firms that are not qualified under 162(m), and the lower 162(m) bonuses are not offset by higher SOC. Our results suggest that 162(m) tax incentives are an important determinant of the decision to expense SOC.     

Rank and file equity compensation and earnings management: Evidence from stock options

The widespread use of rank and file equity‐based compensation suggests that executives believe that rank and file employees can affect firm outcomes, and some research supports this view. If equity‐based incentives influence rank and file employees’ productive efforts, they might also influence their earnings management decisions. We find that increases in rank and file employees’ option‐based compensation—our proxy for equity‐based compensation—are associated with increases in earnings management and that this relation is attributable to real activities (as opposed to accrual) earnings management. Cross‐sectional tests indicate that the relation is stronger when rank and file option compensation is likely to generate greater performance incentives and attenuated in the presence of more intense monitoring. Finally, we explore the role of cash constraints and overvaluation as potential alternative explanations for this relation and find that neither accounts for our results.     

Discussion of “Which approach to accounting for employee stock options best reflects market pricing?”

The objective of the Landsman, Peasnel, Pope and Yeah paper (in this issue) is to compare, for current shareholders, the value relevance of four methods of accounting for employee stock options (ESOs). My discussion provides a unifying framework for the theoretical analyses and the link between the theoretical analyses and the empirical investigation.     

The association between privatisation and voluntary disclosure: Evidence from Jordan

This paper investigates the impact of privatisation on the extent of corporate voluntary disclosure in Jordan.We conduct a longitudinal examination using 243 annual reports of 27 privatised firms in Jordan over a period of nine years from 1996 to 2004. Employing univariate and pooled regression models our results show that privatisation is positively associated with voluntary disclosure. Specifically, we find that accounting regulation reforms and foreign investments accompanying privatisation have a significant impact on the levels of accounting disclosure in Jordan. Our study provides evidence on the role of privatisation in improving the disclosure culture as an important pre‐condition for the development of active capital markets.     

A dynamic analysis of executive stock options: Determinants and consequences

We investigate the determinants of executive stock options (ESOs) and their impact on risky investment and subsequent firm performance in a dynamic setting. We find that, first, the dynamic response of ESOs to growth opportunity and risk is positive and lasts for two to three years. Second, the dynamic response of risky investments to option compensation is positive but converges to zero after three years. More importantly, the positive effect of ESOs on risky investments is observed when CEOs' personal risk-aversion is taken into account. Third, accounting performance responds positively to the risky, option-induced investment, but the dynamic effect lasts only for one year. Meanwhile, when managers undertake more risky investments than what ESOs imply, accounting performance responds negatively to the over-investment.