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.     

A remark on static hedging of options written on the last exit time

In this paper, several different static hedges of the option written on the last exit time are given. One of them was originally presented in Akahori et al. (Methodol Comput Appl Probab 11(4): 661–668, 2009). Another one is derived from an expression in Madan et al. (Asia Pac Financ Mark 15(2): 97–115, 2008d). It is remarked in this paper that these static hedges are also obtained by applying a method in Carr and Chou (Hedging complex barrier options, 2001).     

Expensing stock options: a fair-value approach

Now that companies such as General Electric and Citigroup have accepted the premise that employee stock options are an expense, the debate is shifting from whether to report options on income statements to how to report them. The authors present a new accounting mechanism that maintains the rationale underlying stock option expensing while addressing critics' concerns about measurement error and the lack of reconciliation to actual experience. A procedure they call fair-value expensing adjusts and eventually reconciles cost estimates made at grant date with subsequent changes in the value of the options, and it does so in a way that eliminates forecasting and measurement errors over time. The method captures the chief characteristic of stock option compensation--that employees receive part of their compensation in the form of a contingent claim on the value they are helping to produce. The mechanism involves creating entries on both the asset and equity sides of the balance sheet. On the asset side, companies create a prepaid-compensation account equal to the estimated cost of the options granted; on the owners'-equity side, they create a paid-in capital stock-option account for the same amount. The prepaid-compensation account is then expensed through the income statement, and the stock option account is adjusted on the balance sheet to reflect changes in the estimated fair value of the granted options. The amortization of prepaid compensation is added to the change in the option grant's value to provide the total reported expense of the options grant for the year. At the end of the vesting period, the company uses the fair value of the vested option to make a final adjustment on the income statement to reconcile any difference between that fair value and the total of the amounts already reported.     

孤注一掷救券商

美国大搞资本市场,而我们不搞或是小搞,那就是我们的机遇;美国犯错误而我们不犯错误或少犯错误也是我们的机遇。希望我们能够不再重复美国的错误     

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.     

Price discovery in the U.S. stock and stock options markets: A portfolio approach

Option prices vary with not only the underlying asset price, but also volatilities and higher moments. In this paper, we use a portfolio of options to seclude the value change of the portfolio from the impact of volatility and higher moments. We apply this portfolio approach to the price discovery analysis in the U.S. stock and stock options markets. We find that the price discovery on the directional movement of the stock price mainly occurs in the stock market, more so now than before as an increasing proportion of options market makers adopt automated quoting algorithms. Nevertheless, the options market becomes more informative during periods of significant options trading activities. The informativeness of the options quotes increases further when the options trading activity generates net sell or buy pressure on the underlying stock price, even more so when the pressure is consistent with deviations between the stock and the options market quotes. JEL Classification C52, G10, G13, G14     

Voluntary disclosures and the exercise of CEO stock options

We examine voluntary disclosures around the exercise of CEO stock options. Previous research shows that managerial incentives depend on the intended disposition of the exercised options' underlying shares. When CEOs intend to sell the underlying shares of exercised options, they have an incentive to increase stock prices in the pre-exercise period. In contrast, when CEOs intend to hold the underlying shares, they have a tax incentive to decrease stock prices in the pre-exercise period. Consistent with these private incentives, we find a significant increase in the frequency and magnitude of good (bad) news announcements in the pre-exercise period when CEOs implement exercise-and-sell (exercise-and-hold) strategies. We provide some evidence that CEOs' propensities for opportunistic disclosures are positively related to the value of their exercised stock options. Lastly, we find that the Sarbanes–Oxley Act (SOX) generally reduces, but does not eliminate, this type of managerial opportunism.     

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.     

Analytical approximations for the critical stock prices of American options: a performance comparison

Many efficient and accurate analytical methods for pricing American options now exist. However, while they can produce accurate option prices, they often do not give accurate critical stock prices. In this paper, we propose two new analytical approximations for American options based on the quadratic approximation. We compare our methods with existing analytical methods including the quadratic approximations in Barone-Adesi and Whaley (J Finance 42:301–320, 1987) and Barone-Adesi and Elliott (Stoch Anal Appl 9(2):115–131, 1991), the lower bound approximation in Broadie and Detemple (Rev Financial Stud 9:1211–1250, 1996), the tangent approximation in Bunch and Johnson (J Finance 55(5):2333–2356, 2000), the Laplace inversion method in Zhu (Int J Theor Appl Finance 9(7):1141–1177, 2006b), and the interpolation method in Li (Working paper, 2008). Both of our methods give much more accurate critical stock prices than all the existing methods above.     

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.     

O/S: The relative trading activity in options and stock

Relatively little is known about the trading volume in derivatives relative to the volume in underlying stocks. We study the time-series properties and the determinants of the options/stock trading volume ratio (O/S) using a comprehensive cross-section and time-series of data on equities and their listed options. O/S is related to many intuitive determinants such as delta and trading costs, and it also varies with institutional holdings, analyst following, and analyst forecast dispersion. O/S is higher around earnings announcements, suggesting increased trading in the options market. Further, post-announcement absolute returns are positively related to pre-announcement O/S, which suggests that at least part of the pre-announcement options trading is informed.     

Risk-taking incentives of executive stock options and the asset substitution problem

Various theoretical models show that managerial compensation schemes can reduce the distortionary effects of financial leverage. There is mixed evidence as to whether highly levered firms offer less stock‐based compensation, a common prediction of such models. Both the theoretical and empirical research, however, have overlooked the leverage provided by executive stock options. In principle, adjusting the exercise prices of executive stock options can mitigate the risk incentive effects of financial leverage. We show that the near‐universal practice of setting option exercise prices near the prevailing stock price at the date of grant effectively undoes most of the effects of financial leverage. In a large cross‐sectional sample of Canadian option‐granting firms, we find evidence that executives' incentives to take equity risk are negatively rather than positively related to the leverage of their employers.     

Employee stock options pricing and the implication of restricted exercise price: evidence from Taiwan

Employee stock option (ESO) issuance in Taiwan is associated with some unique characteristics. We believe this to be the first paper to examine the impact of different pricing model options on the theoretical price of ESOs in Taiwan. A clear consensus in terms of the time point to expense the ESO issuance and the setting of a restricted exercise price lead us to believe that the reset pricing model represents the most pertinent model to price Taiwanese ESOs. Furthermore, the factors that determine the decision to impose a restricted exercise price are also discussed. With an outreach of 24 logistic regressions, the empirical results show that the ultimate control power, operational performance and volatility of a firm are important indicators regarding the probability of adding a restriction on the exercise price.     

Issues arising for accounting harmonization: The case of stock options in Italy

In Italy, national generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS) regulations coexist, despite differences that lead to their antagonist forms of accounting relativism. In this context, the two accounting systems provide for different representations of stock options plans, with significant effects on year-end income measures. This study therefore considers the emblematic case of stock options with the goal of demonstrating, on the basis of the dominant accounting principles and conventional wisdom in Italy, that the aforementioned difference cannot be explained by reasons connected with the accounting conceptual framework of reference in each system. Rather, inquiries should focus on weaknesses in national GAAP.     

Valuing executive stock options: performance hurdles, early exercise and stochastic volatility

Accounting standards require companies to assess the fair value of any stock options granted to executives and employees. We develop a model for accurately valuing executive and employee stock options, focusing on performance hurdles, early exercise and uncertain volatility. We apply the model in two case studies and show that properly computed fair values can be significantly lower than traditional Black–Scholes values. We then explore the implications for pay-for-performance sensitivity and the design of effective share-based incentive schemes. We find that performance hurdles can require a much greater fraction of total compensation to be a fixed salary, if pre-existing incentive levels are to be maintained.     

Forecasting stock market volatility and the informational efficiency of the DAX-index options market

Alternative strategies for predicting stock market volatility are examined. In out-of-sample forecasting experiments implied-volatility information, derived from contemporaneously observed option prices or history-based volatility predictors, such as GARCH models, are investigated to determine if they are more appropriate for predicting future return volatility. Employing German DAX-index return data it is found that past returns do not contain useful information beyond the volatility expectations already reflected in option prices. This supports the efficient market hypothesis for the DAX-index options market.     

Impact of liquidity on stock returns: an empirical investigation of the Tunisian stock market

This paper investigates the return–liquidity relationship on one Middle East and North Africa frontier market, the Tunisian Stock Exchange (TSE). The findings provide evidence that there is a significant and positive premium for companies with high price impact and low trading frequency. However, Tunisian investors appreciate more low spread stocks. We show, also, a non-linear relation between potential delays of execution and stock returns. In addition, we find that Tunisian investors require a premium to compensate past cumulative illiquidity risk (high price impact, low turnover and high potential delay of execution) over the prior three to 12 months and to compensate past cumulative spread over 12 months. We point out also that these effects are seasonal.     

Location-specific stock market indices: an exploration

This article develops an alternative location-specific stock market index driven by investors’ ‘attachment’ towards investment at a specific location. We evaluate the performance of hypothetical stock market indices that track companies based on their state of registration, taking the US stock market as our case. Using annual data since 1980 we present raw, risk-adjusted and value-weighted state portfolios’ returns to study the extent to which stock market performance varies by state-level demographics and economic factors. A dynamic panel data estimation – with and without spatial spillover effects – is employed to establish a strong association between stock price performance and the state-level (or geography-weighted) factors. We find that spatial effects are strong and that the ‘spatial attachment’ of companies in interaction with the various location-specific variables imparts an overarching influence on stock-price performance. Comparison of model performances further supports our claims.     

Local time and the pricing of time-dependent barrier options

A time-dependent double-barrier option is a derivative security that delivers the terminal value φ(S _T ) at expiry T if neither of the continuous time-dependent barriers b _±:[0,T]→ℝ₊ have been hit during the time interval [0,T]. Using a probabilistic approach, we obtain a decomposition of the barrier option price into the corresponding European option price minus the barrier premium for a wide class of payoff functions φ, barrier functions b _± and linear diffusions (S _t ) _t∈[0,T]. We show that the barrier premium can be expressed as a sum of integrals along the barriers b _± of the option’s deltas Δ _±:[0,T]→ℝ at the barriers and that the pair of functions (Δ ₊,Δ ₋) solves a system of Volterra integral equations of the first kind. We find a semi-analytic solution for this system in the case of constant double barriers and briefly discus a numerical algorithm for the time-dependent case.