Expensing stock options: The role of publicity*
Chandra Seethamraju
Olin School of Business
Washington University in St. Louis
St. Louis, MO 63130
Tel: (314)-9356113
Seethamraju@wustl.edu
Tzachi Zach
Olin School of Business
Washington University in St. Louis
St. Louis, MO 63130
Tel: (314)-9354528
zach@wustl.edu
First version: September 2003
This version (1.3): January 2004
*
We would like to thank Rajesh Chandra, David Grindler, Matthew Morales, Yan Sun, Mijal Warat and
especially Kristin Haggerty and Amy Rosen for their help in collecting data.
Abstract.
In this paper we offer explanations for why firms began voluntarily adopting the
expensing provisions of FAS 123 in the second half of 2002. First, using two alternative
control samples, we find that firms with greater publicity exposure are more likely to
voluntarily expense stock options, controlling for other factors such as the magnitude of
the stock option expense. This publicity incentive also explains the timing of the
expensing decisions, the summer of 2002, immediately following the accounting scandals
of Enron and WorldCom. Second, we find that valuation benefits from expensing stock
options, proxied by market’s reaction to the proposition by the FASB to undertake a
project requiring firms’ to expense stock options, are positively associated with the
decision to expense. Third, we do not find evidence that corporate governance is
associated with the likelihood to expense options. Finally,
we find some evidence
suggesting that, compared to control firms, expensing firms reduce the number of options
granted in 2002 and have started to make more changes to their compensation plans as
reflected in the most recent proxy statements.
1.
Introduction
Accounting for employee stock options has been a controversial issue since the
late 1980’s and is currently the focus of a national and international debate among
standard setters, managers, investors and academics. In this paper we explore two
research questions related to employee stock options. First, we offer explanations for why
firms began adopting the expensing provisions of Statement of Financial Accounting
Standards 123 (hereafter – SFAS 123) in the second half of 2002.
Until recently, the
overwhelming majority of companies opposed the expensing of stock options on the
income statement. But, starting in July of 2002 firms started voluntarily announcing their
decision to expense stock-based compensation expense. This was the period when the
financial reporting atmosphere was filled with suspicion because of the accounting
scandals involving Enron and Worldcom. This was an opportune time for firms to try and
signal their ‘honesty’ in financial reporting. We argue that managers of firms with more
publicity took advantage of this opportunity and decided to expense stock options. They
hoped to generate positive publicity and obtain the benefits arising thereof. We find
evidence that the amount of publicity enjoyed by a firm played a role in the decision to
expense stock options. Second, we look for evidence linking the option expensing
decision to subsequent changes in the structure of compensation packages firms offer to
their employees. We find some evidence suggesting that expensing firms reduce the
number of options granted in 2002 and have started to make more changes to their
compensation plans.
Current accounting standards require firms to expense most types of
compensation including salaries, cash bonuses and the value of stock grants, but allow
1
firms discretion on whether to expense the value of stock option grants. However,
information about stock option grants, including the total dollar and per share impact of
stock options on net income is available in a footnote, following the adoption of SFAS
123 in 1995. If the market is efficient, and with such unambiguous disclosures, it would
appear that firms should have no objection to expensing options in the body of the
statement on the grounds of mispricing. Many constituents argue that expensing stock
options would have substantial economic consequences. For example, security mispricing
could result from investors’ fixation on income numbers, while failing to understand fully
the cost of stock options or the impact of the underlying accounting choice.
The financial reporting environment entered a period of extreme suspicion on the
part of investors, starting with the Enron bankruptcy in December 2001. The environment
had worsened with the large restatements by Worldcom to the tune of $9 billion. In the
midst of the unfolding accounting scandals, in July of 2002, firms started announcing
their intention to expense stock options. By December 31st 2002, 129 firms had
announced their intention to do so. Nevertheless, this is only a small fraction of the total
number of public firms that potentially could expense stock options.1 In response, the
Financial Accounting Standards Board (hereafter - FASB) issued SFAS 148 which
amends SFAS 123 to provide alternative transition methods for voluntarily adopting the
fair-value method of accounting for stock-based employee compensation.
The FASB also recently voted to put the issue of whether to mandate the
expensing of stock options on its agenda. This was partly in response to increasing
shareholder proposals calling for the expensing of stock options.2 These types of
1
2
As of the end of fiscal-year 2002, Compustat had information on 7,945 firms.
CNN Money, 2003. Anger rising over CEO pay. Appeared on website on April 22nd.
2
shareholder proposals have been receiving the support of pension fund investors and
labor groups.3 Another factor affecting the FASB’s decision was an increased scrutiny of
executive compensation plans in general and of option plans in particular. For example, a
recent article debates removing the one-million-dollar upper limit on deductibility of
CEO compensation in the tax code.4 The article suggests that this would reduce the
reliance on stock options as a form of executive compensation
Our analysis differs from a recent paper by Aboody et al. (2003) (henceforth,
referred to as ABK), dealing with the issue of voluntary expensing of stock options in
several ways. First, we argue that firms’ decision to expense stock options, as well as the
timing of that decision, were mainly influenced by firms’ desire to generate positive
publicity in response to the general negative environment following accounting scandals
such as Enron and WorldCom. Second, we find that valuation benefits from expensing
stock options, proxied by market’s reaction to the proposition by the FASB to undertake
a project requiring firms’ to expense stock options, are positively associated with the
decision to expense. Third, we study alternative and different variables to examine
whether corporate governance is associated with the decision to expense stock options.
Fourth, we also examine whether the decision to expense stock options is accompanied
by firms altering their compensation plans and in particular whether expensing firms tend
to reduce the use of stock options. We do so by hand-collecting data on recent changes to
compensation plans from the most recent proxy statements filed in 2003. We also collect
and analyze data on the number of stock options granted in recent years from financial
statements.
3
4
See, “Executive pay: Labor strikes back” in BusinessWeek, May 26 2003.
Fortune Magazine, 2003a. Mo’ Money, fewer problems. March 31st, page 34.
3
Summary of results. Our evidence supports the notion that firms decided to
expense their stock options to gain benefits arising from favorable publicity. We find that
firms with greater publicity exposure are more likely to voluntarily expense stock
options, controlling for other factors such as the magnitude of the stock option expense.
This publicity incentive also explains the timing of the decisions, the summer of 2002,
immediately following the accounting scandals of Enron and WorldCom. Our other
findings are summarized as follows. First, we find that valuation benefits from expensing
stock options, proxied by market’s reaction to FASB’s proposition to expense stock
options, are positively associated with the decision to expense. Second, we do not find
evidence that corporate governance is associated with the likelihood to expense options.
Finally, we find some evidence suggesting that, compared to control firms, expensing
firms reduce the number of options granted in 2002 and have started to make more
changes to their compensation plans as reflected in the most recent proxy statements.
The rest of the paper is organized as follows. In section 2 we briefly overview the
literature on accounting for stock options. We review in more depth studies related to the
decision to expense stock options. In section 3 we develop our hypotheses. In section 4
we conduct the empirical analysis. Section 5 concludes.
2.
Literature review
2.1 Why firms grant options?
The issuance of stock-options by firms increased dramatically during the late
1990s. This could have been a result of the bull market when many option holders
suddenly became wealthy, creating a frenzy amongst firms to grant additional options to
4
employees. Options came to be viewed by the market as a symbol of firms’ financial
success, even though the empirical evidence on the link between option grants and future
firm performance is inconclusive.
There is a substantial stream of literature about the various reasons firms grant
stock options which we summarize briefly here. The reason cited most often for firms to
grant options (Hall and Murphy, 2003), is that they are the most efficient way to attract,
retain and motivate employees. A second reason for granting stock options is cash
conservation. However, Hall and Murphy (2003) point out that evidence on this issue is
mixed. For example, Core and Guay (2001) examine the determinants of non-executive
stock options and find that firms facing capital requirements and financing constraints use
stock option compensation to a greater extent. On the other hand, Ittner et al. (2003) find
that companies with higher cash flows use options more extensively.
A third explanation, which Hall and Murphy (2003) view as an important one, is
the accounting treatment of stock options. They suggest that the perceived costs of
issuing stock options is lower than the economic cost because there is no accounting
charge against them. This results in firms granting too many options to too many
employees. They suggest that imposing an accounting charge on stock options, which
would not directly affect current or future cash flow, would result in granting fewer
options, especially to rank and file workers.
2.2 SFAS 123
Several recent studies deal directly with SFAS 123. Botosan and Plumlee (2001)
report that stock option expense as calculated under SFAS 123 has a material impact on
various performance measures for a sample of 100 fast-growing companies.
5
Aboody et al. (2002) and Li (2003) find that stock-based compensation expense
has a negative relation with share prices after controlling for reported net income, book
value of equity and expected future earnings growth. This is consistent with investors
viewing the dilutive effect of stock options as more prominent than options’ incentive
effect. In addition, Li (2003) finds that footnote disclosures under SFAS 123
communicate useful information to investors.
In contrast, Bell et al. (2002) report results conflicting with the above two studies
for a sample of profitable computer software firms. They find a positive association
between market value and stock option expense and conclude that the market appears to
value stock option expense as an asset rather than as an expense. However, they also find
a negative relationship between current option expense and future abnormal earnings.
2.3 The option–expensing decision
Several recent studies address the decision of whether or not to expense stock
options which is the focus of our first research question. Aboody et al. (2003), hereafter
ABK, report that the likelihood of expensing options is significantly related to (i) the
magnitude of the expense and its effect on reported earnings, (ii) the existence of
accounting-based compensation contracts, (iii) the firm’s investor base and governance
structure, (iv) the extent to which the firm is active in the capital market, and (v) whether
the firm is a leader in its industry. In addition, first-announcers have significant positive
announcement date abnormal returns.5 Guay et al. (2003) predict that the corporate
5
Daniel et al. (2003) do not find evidence of a significant announcement- day stock price reaction. Like
ABK, they also find a negative relation between the size of the expected expense and the decision to
expense.
6
governance of expensing firms is more effective than that of non-expensers. Like ABK,
we test this prediction.
Our analysis is different from ABK in that we focus primarily on publicityseeking incentives and valuation effects. Our paper also differs from ABK in some of the
metrics used to measure corporate governance. We elaborate on these and other
differences in the next section.
Finally, Johnston-Wilson (2003) finds evidence that expensing firms manipulate
the volatility assumption downward (relative to non-expensing) firms to reduce the stock
option expense recognized in their financial statements.
3.
Hypotheses development
In this paper we explore the underlying incentives that lead firms to adopt the
recommended treatment for stock options as described in SFAS 123, specifically, to
expense the cost of stock options. We hypothesize that firms would choose to expense
their stock options if either (i) the relative costs of adoption are low and/or (ii) the
perceived benefits are high. We identify several costs and benefits that are relevant for
firms’ decisions and develop alternative proxies to capture these costs and benefits.
Our paper is different from ABK in that we focus primarily on publicity-seeking
incentives. We argue that an important benefit playing a role in the decision to expense
stock options, as well as its timing, is firms’ desire to signal that they are ‘good citizens’.
In other words, generating positive publicity is an important element in trying to build a
positive reputation. This incentive not only explains the decision to expense stock
options, but also the timing of that decision – the summer of 2002 immediately following
7
Enron’s and WorldCom’s accounting scandals. At that time the potential benefits from
generating positive publicity were at their peak. We believe that this is a novel incentive
that has not been explored in the accounting literature, even though there is some
anecdotal evidence hinting at its importance. For example, a recent article suggests that in
order to get positive publicity, Citigroup unilaterally announced its decision to expense
stock options before other financial institutions despite its opposition to expense stock
options expressed in earlier meetings with its industry peers.6 In the context of the
decision to expense stock options, another article in Fortune magazine raises the
possibility that “investors are rewarding companies for something that is sorely missing
these days: honesty”.7
We view this benefit as similar to the political costs arguments in Watts and
Zimmerman (1986). While their argument refers to firms seeking to avoid public scrutiny
by reducing earnings, our argument is about firms seeking to attract public attention and
signal their ‘honesty’. Publicity benefits can potentially accrue to different categories of
firms. The thrust of our first set of hypotheses is aimed at studying firms that desire
publicity to help them be perceived as ‘good citizens’. Our maintained assumption is that
increased publicity is beneficial to firms. However, we do not attempt to document how
benefits from increased publicity manifest themselves through, for example, increased
valuations, lower cost of capital, enhanced reputation and increased demand in product
markets.
6
Fortune Magazine. Citigroup, Whatever it takes. November 10th, 2002.
7
Fortune Magazine. A little honesty goes a long way. September 2nd, 2002. page186.
8
3.1
Publicity
Hypothesis 1. Our first hypothesis deals with the set of firms that are exposed to a
lot of publicity and continuously attract the attention of market participants. For these
firms, whose publicity channels are well established, attracting attention from a large
investor base is fairly easy. Thus, the perceived benefits of an announcement to expense
stock options could be high, since it would get a lot of media coverage and potentially
make investors view the firm more favorably. Hence, we predict that firm with high
levels of publicity are more likely to recognize stock-based compensation expense.
Empirically, we measure a firm’s publicity exposure as the natural logarithm of
the number of articles appearing in The Wall Street Journal about the firm in 2001. We
believe that on a relative basis, this measure adequately separates the highly-visible firms
from other firms. We choose articles in 2001 to make sure that the article count is not
affected by the announcement to expense options in 2002.
Recently, Barton (2003) provides evidence that a media exposure variable, similar
to ours, is positively associated with the decision to replace Arthur Andersen as an
auditor. He attributes this finding to firms’ desire to either increase or not decrease their
perceived reputation among market participants.
Hypothesis 2A. This hypothesis deals with firms that may want to reduce penalties
that the stock market had imposed on them in the past. These firms could have fallen out
of favor with investors as reflected by their stock market performance in the previous
fiscal year. These firms may believe that an announcement to expense options would
improve their public image. As a proxy for previous capital market penalties, we use the
stock price performance in the prior fiscal year. We predict that stock price performance
will be negatively associated with the likelihood of expense recognition.
9
Hypothesis 2B. This hypothesis deals with firms interested in preventing future
penalties because they have something to hide. In other words, these firms expect future
penalties and would like to pre-empt any expected future increased scrutiny. For
example, these firms may have managed earnings in the recent past and expect the
effects to catch up with them in the future. They could resort to signaling that they are
‘honest’ and try and pre-empt greater scrutiny from investors. To identify these firms we
use abnormal accruals derived from the modified Jones model. We expect that firms that
managed earnings would be more likely to recognize stock option expense .
3.2
Valuation benefits
Hypothesis 3. Our third hypothesis deals with perceived valuation benefits of
expensing stock options. One potential benefit from expensing stock options is increased
market value. The increase in market value can result from various sources. For example,
increased reputation, improved quality of earnings, better alignment of shareholdersemployees’ interests and a more optimal use of stock options in the future. In this
hypothesis we are not exploring a particular
source of these benefits. Instead, we
examine the effect on firm value that the decision to expense may have. As a proxy for
potential valuation benefits, we calculate the three-day abnormal returns around January
21, 1992, the date on which FASB initially announced its intention to undertake a project
requiring firms to expense stock option compensation (see Espahbodi et al., 2002). Thus,
we use the market as a gauge on whether expensing stock options is a value-enhancing
endeavor. We hypothesize that firms with higher three-day abnormal returns are more
likely to expense stock options. Therefore, we expect that the return around this window
is positively associated with the likelihood of expensing.
10
3.3
Corporate Governance
Hypothesis 4. This hypothesis deals with firms’ corporate governance structure.
Following Guay et al. (2003) we hypothesize that a strong corporate governance structure
would lead to increased board scrutiny over management and to a higher likelihood of
expensing stock options. While similar in spirit, our analysis of corporate governance
differs from
ABK in some of the metrics used to measure corporate governance.
Employing a unique database that covers various aspects of corporate governance, our
first corporate governance proxy is the percentage of outsiders serving on the board of
directors. The second and third proxy we use are the shareholdings of outside and inside
directors. Larger number of outsiders and larger outsider holdings are expected to be
associated with stronger corporate governance. Thus, we predict that the percentage of
outside directors and outside (inside) directors’ shareholding will be positively
(negatively) related to the likelihood of expense recognition.
3.4
Additional Hypotheses
Hypothesis 5. This hypothesis deals with the impact of stock options on the
bottom line. One of the costs of expensing stock options is its effect on net income and on
accounting-based contracts (e.g. bonuses, debt covenants). Firms for which the impact of
option expense on net income is low, may seek to capitalize on this opportunity and, at
the same time, signal their leadership in the area of improving the financial reporting
environment. Consistent with ABK, we expect to find a negative relationship between the
amount of stock-based compensation expense and the expensing decision. Larger
expenses indicate higher costs and therefore a lower incentive to recognize the expense.
11
We use option expense deflated by total assets to proxy for the relative magnitude of the
expense and expect a negative association with expense recognition.
Hypothesis 6. On the other hand, there could be firms that are doing well
financially as measured by net income. These are firms that could easily absorb the
impact of stock option expense and would hence elect to expense stock options.
Therefore we expect that financially stronger firms were more likely to expense stock
options. To measure financial strength, we use both net income deflated by total assets
and stock returns in the most recent fiscal year. A positive coefficient on these variables
is consistent with our prediction.
Hypothesis 7. This hypothesis relates to institutional investors. Similar to ABK
we include institutional ownership as an explanatory factor, but do not predict the sign of
its relation with the likelihood of expense recognition. As discussed in ABK, the presence
of institutional investors can affect the decision to expense stock options in two ways,
which depend on the investment perspective of the institution (Bushee, 1998). If the
institution has a short-term focus, managers may act myopically and focus on short-term
earnings, avoiding any unnecessary expenses. In our context this would lead firms to
avoid the expensing of stock options. On the other hand, when institutions’ focus is longterm they are likely to apply pressure on management to improve the quality of reported
earnings. In this case, a positive relationship between institutional ownership and the
decision to expense is predicted.
Hypothesis 8. The eighth hypothesis deals with firms’ stock option plans. On the
one hand firms by deciding to expense stock options, may be signaling that their financial
statements are of a higher ‘quality’. On the other hand firms may be making changes to
12
their stock option plans which would reduce the impact that the decision to expense stock
options has on their financial statements. After firms announced expensing of stock
options during 2002, we collected the proxy statements that were filed with the SEC
during the early part of 2003 and conducted an analysis of these statements. We expect
that sample firms would have greater number of changes in their stock option plans than
control firms.
4.
4.1
Empirical Analysis
Data
Sample. We identify 129 sample firms that as of December 31, 2002 announced
their intentions to expense their stock options. Part of our analysis is based on a matched
sample of firms as follows. We match each sample firm with a control firm, that did not
announce the expensing of stock options as of December 31, 2002. Our matching
procedure is performed based on industry classification (SIC codes) and market
capitalization at the beginning of 2002. We require each control firm to be within 20% of
its counterpart sample firm’s market capitalization. We start the matching process based
on four-digit SIC codes. If no match is found, we move to three- and two- digit SIC
codes.
Other parts of our analysis are performed on a sample that includes all firms in the
S&P500, S&P400 or S&P600 that have not announced the expensing of stock options as
of the end of 2002 (hereafter referred to as the S&P sample).
Stock option information. For each of our sample and control firms, we handcollect historical information on stock option expense and on stock option grants from
footnotes in firms’ financial statements for the 1997-2001 period. This information
13
includes the stock option expense that would have been included in the income
statements had the firms chose to expense their stock options. For the wider S&P sample
and for a limited set of sample and control firms for which we could not track the
financial statements, we compute pro-forma stock option expenses based on item # 399 in
Compustat.8
Proxy data information. For each of our control and sample firms, we obtain the
most recent proxy statement that was published between July 1, 2002 and June 30, 2003.
We identify firms along the following (non-mutually-exclusive) dimensions: (i) firms that
presented new stock-based compensation plans for a vote at shareholder’s meeting, (ii)
firms that amended existing stock-based compensation plans, and (iii) firms whose proxy
statements do not have evidence of their belonging to either of the above two categories.
We classify firms in the first two groups (new plans or amendments to old plans) into two
categories:. (i) Minor revisions – the changes in plans do not directly involve option
compensation to employees. These can include changes in directors’ plans and changes in
retirement benefits. (ii) Major revisions - the changes in plans directly involve option
compensation to employees. These include introductions of new plans or specific changes
to options compensation.
Other data. Financial statement data is obtained from COMPUSTAT. Stock
return data is obtained from CRSP. Corporate governance data is obtained from a
proprietary database provided by a commercial vendor. Publicity data is based on article
8
This item is only partially covered, which is why we opted for hand collection for sample and control
firms.
14
counts from the Wall Street Journal.9 We obtain data on the format used to announce the
expensing of stock options from press releases on companies’ web sites and\or from wire
stories through Factiva.
Variables. All variables are reported for the year 2001 or as of the end of that
fiscal year, unless otherwise indicated. RET12 is the size-adjusted return on sample
firms’ stock in fiscal year 2001. BM is the book-to-market ratio. (LN_)SIZE is the
(natural logarithm of) market capitalization as of the beginning of 2002. LEV is leverage
measured as the ratio of total liabilities to total assets. PE is the price-to-earnings ratio.
OPT_EXPENSE is the 2001 pro-forma option expense as reported in the stock options
footnote deflated by total assets. NIBEI is net income before extraordinary items deflated
by lagged total assets. NI is net income deflated by lagged total assets. CFO is cash flow
from operations deflated by lagged total assets. OUT_DIR is the percentage of outside
directors on the board. PCT_OUT is the percentage of shares held by outside directors
(for most firms as of December 2002). PCT_IN is the percentage of shares held by
insiders (for most firms as of December 2002). INST is the percentage of shares held by
institutions (for most firms as of December 2002). Publicity is the number of articles
appearing in Wall Street Journal for each firm during 2001 and PUB is the natural
logarithm of that number.10 RET123 is the 3-day return around January 21, 1992, the date
on which FASB announced its intent to expense stock option compensation. DA_MJ is
abnormal accruals estimated using the modified-Jones model. Some of the variables were
not available for all firms.
9
For each sample and control firm, we use Factiva to count the number of articles in which a particular
firm is mentioned in the Wall Street Journal during 2001 and 2002 (separately). To identify articles
associated with sample or control firms, we use Factiva’s Intelligent Indexing feature.
10
For firms with no articles, we equate the logarithm to zero.
15
4.2
Descriptive Statistics
Panel A of Table 1 tracks our matching procedure. We start with 133 sample
firms. Four firms were already expensing options for some time before July 2002 so we
eliminate them.. For twenty firms, we could not find sufficient size information and
therefore did not match them with a control firm. We could not locate stock option
footnote data for eighteen expensing firms and one control firm.
Panel B of Table 1 indicates that 40 firms were matched with a control firm based
on 4-digit SIC codes. If no match was found at the four-digit level we turn progressively
to 3, 2 and 1-digit matches. Finally, if no match was found we perform a two-digit match
but drop the requirement that the size of sample and control firms’, as measured by
market capitalization, be within 20% of each other.
Table 2 reports summary statistics for sample firms and for the S&P sample
group, which includes firms belonging to one of S&P 500, S&P 400 or S&P 600 and had
not chosen to expense their stock-based compensation as of December 2002. The table
also reports the p-values from a Wilcoxon rank-sum test for differences in medians across
the two samples.
Several points are worth noting. Expensing firms are bigger, in terms of revenues,
total assets and market capitalization. Their mean revenues are $ 16.7 billion compared to
$ 3.9 billion for S&P firms. The medians, which are different between sample and S&P
firms among all size-related variables, reflect a similar picture.
Sample firms are more levered (LEV), with a median Liabilities-to-Assets ratio of
0.75 compared to 0.56 for S&P firms. The PE ratio is higher for the S&P group than for
the sample group. The medians are 22.1 compared to 18.5 (p-value of 0.043). Note that
16
the means of PE ratio behave differently, as a result of several extremely high values in
the sample firms.
Turning to OPT_EXPENSE, pro-forma option expenses scaled by assets, we find
that the mean (median) OPT_EXPENSE is 0.46% (0.10%) for sample firms while it is
1.46% (0.41%) for S&P firms. This is consistent with firms whose option expenses are
relatively small in magnitude choosing to expense their stock options.
Expensing firms are less profitable and their cash flows from operations are
lower. Net income before extraordinary items has a median of 0.02 in expensing firms
compared to a median of 0.04 among S&P firms. All the above three variables are much
more skewed and dispersed in the smaller sample group, leading their means to behave
differently from the medians. Nevertheless, medians are significantly different from each
other across the two groups (weakly so, in the case of NI – p-value 0.078).
Institutional ownership is also different across the two groups. Expensing firms
have lower institutional ownership than S&P firms with a median of 55.3% compared to
68.1%.
Finally, the stock returns around the 1992’s FASB announcement that it would
consider expensing stock options, are higher in the sample group, with a mean value of
1.54%, than in the S&P group, whose a mean is 0.22%.
Table 3 reports medians of several variables of interest for sample firms only.
Statistics are reported separately based on the format in which the announcement about
expensing stock options was conveyed to the market. Firms in group 1 issued a special
press release that was solely dedicated to the stock expensing issue. Firms in group 2
issued a press release that contained stock option expensing along with other information.
17
Firms in group 3 announced their expensing of stock options in conjunction with the
quarterly earnings announcement. We could not find any special press release for firms in
group 4. For firms in group 5 we found an article in the business wires describing their
decision but we could not find the origin of the article in the form of a press release. It is
possible that these firms mentioned the information in another channel (e.g. during a
conference call).
We conduct Wilcoxon rank-sum tests (unreported) but do not detect any
differences between the various groups. Part of that could be attributed to the low power
of these tests as a result of the small number of firms in each group. One notable
difference is that firms in group 3 are much smaller than firms in groups 1 and 2 in terms
of revenues, total assets and market capitalization. Another difference related to size, is
that firms in group 3 have lower public exposure. The median number of articles
appearing in the Wall Street Journal for this group is 2.5 compared to 5.5 and 6 in groups
1 and 2.
4.3
Correlations
The correlations for the various variables are presented in Table 4. We find that
Publicity is significantly positively correlated with size (correlation coefficient =0.78).
This is to be expected as larger firms are generally more visible.
The option expense variable, OPT_EXPENSE, is significantly negatively
correlated with book-to-market ratio and leverage. This suggests that firms with greater
future expected growth prospects, as measured by a lower book to market ratio, would
have higher levels of option expense and less leverage. Both predictions are consistent
18
with young and growth firms being heavy users of options and employing less debt in
their capital structure.
4.4
Regression model
To conduct an analysis of our hypotheses, we estimate the following logit
equation:
RECOGNIZE =β0 + β1 RET12 + β2 LN_SIZE + β3 OPT_EXPENSE +
β4 BM + β5 LEV + β6 NI + β7 PUB+β8 INST +β9 OUT_DIR +
β10 PCT_OUT + β11 PCT_IN + β12RET123+β13DA_MJ,
(1)
where the variables are as defined in section 4.1.11
The dependent variable, RECOGNIZE, is an indicator variable which equals one
for sample (expensing) firms and zero for control firms. We estimate the model for both
sets of samples –matched sample and S&P sample.
4.5
Results for Matched Sample
We present the results from estimating equation (1) for the matched sample in
Table 5. A base model is presented under Model 1. We find that LEV loads positively
suggesting that the probability of recognizing option expense is increasing in the degree
of leverage. The option expense variable, OPT_EXPENSE, is marginally significant and
negatively related to the likelihood of expense recognition.
Moving to Model 2, where we add PUB, we find that OPT_EXPENSE is
significantly negatively related to the likelihood of expense recognition. This is consistent
with ABK and hypothesis 5 and suggests that firms with greater stock-based
11
The matched sample includes a number of financial institutions for whom it is not possible to calculate
the discretionary accruals variable, DA_MJ. This results in a substantial loss in sample size. Hence, we
drop the variable from the analysis for the matched sample.
19
compensation expense are less likely to voluntarily recognize the expense in the income
statement. We still find that LEV is significantly positive.
Consistent with our first hypothesis, the publicity variable is positive and
significant. This result implies that the more a firm is in the focus of the business press
and investors, the more likely it is to recognize stock based compensation expense. After
controlling for publicity the size variable, LN_SIZE, is negative and becomes significant
suggesting that larger firms are less likely to recognize option expense. The negative
sign is not consistent with the positive coefficient on size in ABK and in our Table 6
discussed in section 4.6. It is also inconsistent with the political cost hypothesis, which
argues that large firms are more likely to recognize expenses to shield off scrutiny over
large profits. Since publicity is not controlled for in ABK, we believe that size in ABK
serves as a proxy for publicity. The positive coefficient on size in ABK, while consistent
with a political cost argument, actually tells the publicity story.
In model 3 we add the governance and institutional ownership variables. We find
that RET12, the size-adjusted return on sample firms’ stock fiscal year 2001, turns
positive and significant. This indicates that firms whose stock price performed better in
the previous fiscal year were more likely to expense stock options. This result is
consistent with hypothesis 6 and inconsistent with hypothesis 2A. As in model 2, we still
find that the coefficients for LN_SIZE, OPT_EXPENSE and PUB have the same sign
and are significant. We also find that institutional holding, INST_PCT, is negatively and
significantly related to the decision to recognize stock option expense. This result is
consistent with ABK.
20
In model 4, we estimate the full version of our model after adding RET123, the
three-day size-adjusted return around January 21, 1992, the date on which FASB
announced its intention to undertake a project requiring firms’ to expense stock option
compensation. Not all firms in the sample and control groups were in existence in 1992
and as a result the number of observations drops to 144. Stock price performance in the
previous fiscal year (RET12) and the publicity variable (PUB) remain positive and
significant. OPT_EXPENSE continues to be negative and (weakly) significant.
Consistent with hypothesis 3, RET123 is positive and significantly related to the decision
to recognize stock option expense. This suggests that firms for which the announcement
by the FASB in 1992 was perceived by the market to be good news, are more likely to
recognize stock option expense. The coefficients on institutional holding (INST_PCT)
and size (LNSIZE), are no longer significant. The loss of significance, compared to
model 3, can partly be attributed to the decrease in the number of observations. When we
re-run model 3 only with observations with valid data to run model 4, we find that
OPT_EXPENSE, LN_SIZE and INST_PCT are not significant.
In untabulated tests we compute the marginal effects of the various independent
variables on the probability of expensing options. We present graphs depicting the
marginal effects of the magnitude of the option expense and of publicity on the
probability to expense stock options in Figures 1A and 1B.12 The graph indicates that the
probability of expensing is high when the magnitude of the expense is very low. The
probability drops steeply with small increases in stock option expense. When the
magnitude of the expense reaches 5% of total assets, the probability does not change as a
12
To better interpret the marginal probabilities, the graphs are based on a different specification of our
model substituting the log of the option expense instead of OPT_EXPENSE and only including the
significant variables of model 4 in table 5.
21
result of further increases in the magnitude of the expense. The untabulated results
indicate that, holding all other variables at their mean level, an increase in option expense
from 0.14% of total assets to 0.37% of total assets results in a decrease of 7 percentage
points in the probability that a firm would expense stock options.
The marginal effects of publicity are presented in Figure 1B. The probability of
expensing is low for firms with low levels of publicity. However, a small increase in
publicity dramatically increases the probability of expensing stock options. This
probability tapers off when publicity is above 50. Any increase in publicity at this level
does not significantly increase the probability of expensing. Untabulated results indicate
that, holding all other variables at their mean level, an increase in the article count from 5
to 14, increases the probability of expensing by 12 percentage points.
4.6 Results for S&P Sample
We estimate equation (1) for the S&P sample with all variables for which
data is available. The results are presented in Table 6. To use as many observations as
possible, we first run a base model, model 1, which excludes PUB, RET123 and DA_MJ.
In general, the results are similar to those of the matched sample in Table 5. Leverage
(LEV) is still positively and significantly related to the decision to expense stock options.
The magnitude of the option expense, OPT_EXPENSE, is negatively related to the
decision to expense stock options. Consistent with ABK, we also find a negative
association between institutional holdings and the decision to expense. LN_SIZE is
positively related to the decision to expense. As we argue in the previous section, we
22
believe this is a result of size proxying for publicity. In fact, when publicity is included in
model 2, the coefficient on LN_SIZE is negative and no longer significant.
To test hypotheses 1 and 2B, we add the publicity variable (PUB) and DA_MJ,
abnormal accruals estimated using the Modified Jones model, to the regression and
estimate it under model 2 in Table 6.13 Recall, that we would like to test whether publicity
and earnings management are associated with the decision to expense stock options. The
coefficient on PUB is positive and significant. The discretionary accrual variable,
DA_MJ is negative and weakly significant, suggesting that earnings management does
not play a significant role in the decision to expense stock options. The other results are
similar to those in model 1, except that OPT_EXPENSE is marginally significant and net
income becomes significant. As mentioned earlier, when publicity is included in model 2,
the coefficient on LN_SIZE is negative and no longer significant.
In model 3 we add RET123, the three-day size-adjusted returns around January
21, 1992, as an explanatory variable. This restricts the analysis to the sub-sample of firms
which were in existence in January 1992 and had enough data to calculate abnormal
accruals. We find that leverage, net income, PUB and RET123 are positive and
significant. Option expense is negative and significant. The discretionary accrual
variable, DA_MJ, is not significant.
Similar to the previous section, in untabulated results we compute the marginal
effects of the independent variables on the probability of expensing options. In Figures
2A and 2B we present graphs of the marginal effects of the size of the option expense and
13
This hypothesis was not tested in Table 5 because we could not calculate abnormal accruals for a large
number of our control sample.
23
of publicity on the probability to expense stock options.14 The graph indicates that the
probability that a firm will expense stock options is high when the option expense is very
low. The probability decreases as the magnitude of stock option expense increases,
though not as dramatically as it does for the matched sample.
The untabulated results indicate that, holding all other variables at their mean
level, an increase in option expense from 0.32% of total assets to 0.86% of total assets
would result in a small decrease of 0.3 percentage points in the probability that a firm
would expense stock options.
The marginal effects of the publicity variable are presented in Figure 2B. The
figure indicates that the probability of expensing is low for firms with low publicity
exposure. However, a small increase in publicity dramatically increases the probability of
expensing stock options. This probability increases at a declining rate as publicity
increases further. Untabulated results indicate that, holding all other variables at their
mean level, an increase in the article count from 3 to 8, increases the probability of
expensing by 1 percentage point.
Summary. To summarize the results of this section, we find support for hypothesis
1, a positive and significant association between firms’ publicity exposure and the
decision to expense stock options. We believe that the positive relation of size and the
expensing decision in ABK and in Table 6 of our paper, is attributed to omitting the
publicity variable. With respect to hypothesis 2B, we do not find evidence that the
decision to expense is related to the likelihood of firms engaging in earnings
management, proxied by abnormal accruals. There is no evidence of a negative
14
To better interpret the marginal probabilities, the graphs are based on a different specification of our
model substituting the log of the option expense instead of OPT_EXPENSE and only including the
significant variables of model 3 in table 6.
24
association between recent stock performance and the decision to expense options
(hypothesis 2A). We find strong evidence that the decision to expense is associated with
potential benefits that the firms may gain in terms of market value, which is proxied for
by stock price reaction to FASB’s announcements of putting options expensing on its
agenda (hypothesis 3). We do not find any support to the claim that corporate governance
is related to the expensing decision (hypothesis 4). We find that the decision to expense is
negatively related to the magnitude of the expense (hypothesis 5). There is evidence that
more profitable firms are more likely to expense (hypothesis 6). Finally, institutional
ownership is negatively related to the expensing decision, in most specifications. This is
not consistent with institutions putting pressure on firms to enhance their accounting by
expensing stock options.
5.
Expensing decision and changes to compensation plans – Univariate analysis
Our second question, related to hypothesis 8,
asks whether the decision to
expense stock options is accompanied by changes to compensation plans. Under one
scenario firms that choose to expense their stock options can still avoid the expense by
either reducing or eliminating altogether the use of stock options. For example,
Amazon.com announced in late 2002 that it would reduce the use of stock options and
instead issue restricted stocks. Although restricted stocks would still need to be expensed,
Amazon stated that it would need to recognize less expenses for the same amount of
incentives it provides using restricted stocks. Microsoft, regarded by many as the pioneer
25
of option-based compensation, also announced its move from options to restricted
stocks.15
In this section we report preliminary evidence regarding (i) the option granting
behavior of sample and control firms in 2002, (ii) changes made to compensation plans
that were announced in proxy statements filed up to June 30, 2003.
5.1
Options grants
We collect data on option grants to all employees from the option footnotes in the
financial statements for the matched sample. We also extract data on options granted to
the Top 5 executives in each firm from the 2002 Execucomp database.
Summary statistics of our findings are presented in Table 7. The median sample
(control) firm in our sample increased the options granted to all employees by 3.2 %
(5.3%) in 2001, the year before the decision to expense stock options was announced.
Interestingly, in 2002 sample firms actually reduced the number of options granted by
7.2%, while control firms continued to increase their option grants, albeit at a slower rate
of 1.4%. The difference is significant at the 10% level. This provides preliminary
evidence suggesting that sample firms started cutting back on stock options in 2002, the
year in which they decided to recognize stock based compensation expense.
In terms of the options granted to the top 5 executives we document a similar
finding. Control firms reduced their option grants in both years, but there was a negligible
decline in their option grants in the year 2002. The median control firm reduced the
number of options granted by 5.5% in 2001 compared to a reduction of 0.1% in 2002.
Sample firms on the other hand had no change in the number of options granted in 2001,
15
Amazon announced its expensing of stock options in July 2002 and therefore is included in our sample.
Microsoft’s announcement of both the move to restricted stocks and the expensing of prior stock options
issues was announced in July 2003 and therefore Microsoft is not included in our sample.
26
but reduced them by 13.3% in 2002. Thus, grants of options to top executives of sample
firms fell sharply in 2002, the year in which they decided to recognize stock based
compensation expense.
5.2
Compensation plans
We next investigate whether there is any evidence that expensing firms began to
make changes to their overall compensation plans in conjunction with the decision to
expense stock options. To do so, we collect information from the most recent proxy
statements of both sample and control firms filed between July 1, 2002 and June 30,
2003. We report preliminary evidence in panel C of Table 7. Each firm is classified on
the basis of the changes made to its compensation plans. First, we find that 57% of
expensing firms made changes to their compensation plans, compared with about 40% of
control firms. Second, we find that about 28% of expensing firms made major revisions
to their compensation plans compared to 17.5% of control firms. Major revisions are
defined as changes in plans that directly involve option compensation. These can include
introductions of new plans or specific changes to options compensation.
Collectively, we view these results as evidence that expensing firms were more
likely to accompany their decision with a change to their compensation plans.
6.
Conclusions
In this paper we argue that the wave of firms announcing their decision to expense
stock options in summer 2002 was mainly driven by the need to generate positive
publicity and to signal to investors that they are ‘honest’. Using two alternative sets of
control samples, we show that the decision to expense options is positively associated
27
with the number of Wall Street Journal articles in which a firm appeared during the prior
year. We believe that the potential benefits from positive publicity related to favorable
accounting decisions was at its peak during the summer of 2002, immediately following
the accounting scandals of Enron and WorldCom. At that time, public scrutiny of
compensation packages, in general, and option compensation in particular was very high.
We also find evidence that the decision to expense options is positively associated
with the potential valuation benefits that can accrue to firms as a result. We do not find
evidence that stronger corporate governance is associated with greater likelihood to
expense options.
Finally, we argue that the decision to expense stock options is related to the
design of compensation packages. We report evidence that, compared to a control sample
of firms that did not expense stock options, expensing firms reduced their options grants
to their employees and their top executives. Also, we show that expensing firms were
more likely to make changes to their compensation plans in conjunction with the decision
to expense.
28
References
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Aboody, D., M. Barth and R. Kasznik, 2002. SFAS 123 stock-based compensation
expense and equity market values. Working Paper, Stanford University.
Aboody, D., M. Barth and R. Kasznik, 2003. Factors associated with Firms’ decisions to
improve earnings quality: The voluntary recognition of stock-based compensation
expense. Forthcoming Journal of Accounting Research.
Barton, J., 2003, Who cares about auditor reputation. Working paper, Emory University.
Bell, T., W. R. Landsman, B. Miller and S. Yeh, 2002. The valuation implications of
employee stock option accounting for profitable computer software firms. The
Accounting Review 77 (October):971-96.
Bushee, B.J., 1998. The influence of institutional investors on myopic R&D investment
behavior. The Accounting Review 73” 305-33.
Core, J.E, W.R. Guay and S.P. Kothari, S.P. 2003. The Economic Dilution of Employee
Stock Options: Diluted EPS for valuation and financial reporting. Forthcoming
The Accounting Review.
Core, J. and W.R. Guay, 2001. Stock Option Plans for Non-executive employees. Journal
of Financial Economics. 61:2, 253-87.
Dechow, P., R. Sloan and A. Sweeney, 1995. Detecting earnings management. The
Accounting Review 70 (April): 193:226.
29
Daniel, N.D., J.R. Kale and L. Naveen, 2003. Do option expensing announcements
convey information to the stock market. Working Paper, Georgia State
University.
Espahbodi, H., P. Espahbodi, Z. Rezaee and H. Tehranian. 2002. Stock Price reaction
and value relevance of recognition versus disclosure: the case of stock-based
compensation. Journal of Accounting & Economics : 343-73.
Guay, W, S.P. Kothari and R. Sloan. 2003. Accounting for employee stock options.
Forthcoming American Economic Review.
Hall, B. and K. Murphy, 2003. The trouble with Stock Options. Working Paper, NBER
and University of Southern California and Harvard University.
Johnston-Wilson, D., 2003. Managing stock option expense: The manipulation of option
pricing model assumptions. Working paper, Colorado State University.
Li, H., 2003. Employee stock options, residual income valuation and stock price reaction
to SFAS 123 footnote disclosures. Working paper. University of Iowa.
Watts, R. and J., Zimmerman, 1986, Positive Accounting Theory, Prentice Hall.
30
Table 1
Panel A: Matching procedure
Firms
Initial sample
133
Firms that expensed stock options prior to July 2002
(4)
Firms with insufficient size information to obtain a control firm
(20)
Firms to which we could not find data on stock options in footnotes or firms whose
(18)
footnotes we could not locate
Firms whose control firm stock option information could not be found
(1)
90
Panel B: Matching details
Four-digit SIC codes
40
Three-digit SIC codes
12
Two-digit SIC codes
15
One-digit SIC codes
13
Two-digit SIC codes (Size requirement of within 20% dropped)
10
31
Table 2
This table reports summary statistics of various variables, separately for sample firms and the S&P sample
firms. Sample firms consist of 129 firms that announced the expensing of stock options between July 2002 and
December 2002. The S&P sample consists of 1,373 firms in the S&P 500, 400 and 600 groups that did not
choose to expense their stock options by December 2002. The table also reports the p-values from Wilcoxon
rank-sum tests of differences in medians between the two groups (Wil).
All variables are reported for the year 2001 or as of the end of that fiscal year, unless otherwise indicated. The
reported variables are: BM is the book-to-market ratio. Size is the market capitalization as of the beginning of
2002. Revenues and total assets are reported in thousands of dollars. Size is market capitalization in thousand.
LEV is leverage measured as the ratio of total liabilities to total assets. PE is the PE ratio. OPT_EXPENSE is
the 2001 pro-forma option expense as reported in the stock options footnote scaled by total assets. NIBEI is net
income before extraordinary items deflated by lagged total assets. NI is net income deflated by lagged total
assets. CFO is cash flow from operations deflated by lagged total assets. PCT_OUT is the percentage of shares
held by outside directors (for most firms as of December 2002). PCT_IN is the percentage of shares held by
insiders (for most firms as of December 2002). INST is the percentage of shares held by institutions (for most
firms as of December 2002). Publicity is the number of articles appearing in Wall Street Journal for each firm
during 2001. RET123 is the 3-day return around January 21, 1992, the date in which FASB announced its
intent to expense stock option compensation. Some of the variables were not available for all firms.
Sample (expensing) firms
S&P sample
Mean
Median
Std
Mean
Median
Std
Wil
BM
0.48
0.49
0.44
0.501
0.434
0.354
0.273
Revenues
16,696
4,329
33,452
3,953
1,132
9,483
0.000
Total assets
80,788
10,001
175,172
7,044
1,438
21,263
0.000
Size
24,110
4,673
55,321
6,053
1,354
21,056
0.000
LEV
0.74
0.75
0.24
0.54
0.56
0.24
0.000
PE
47.11
18.53
154.13
43.32
22.13
155.38
0.043
OPT_EXPENSE
0.46%
0.10%
1.77%
1.46%
0.41%
3.15%
0.00
NIBEI
0.04
0.02
0.14
0.03
0.04
0.13
0.021
NI
0.04
0.02
0.14
0.03
0.04
0.13
0.078
CFO
0.12
0.07
0.23
0.12
0.11
0.11
0.001
PCT_OUT
0.81
0.20
1.61
0.95
0.35
2.24
0.000
PCT_IN
6.12
1.69
11.98
5.86
2.58
9.19
0.000
INST
55.3%
60.0%
22.8%
68.1%
69.1%
29.6%
0.000
Publicity
30.11
6.00
65.30
7.6
2.00
23.34
0.000
RET123
1.54%
0.92%
4.75%
0.22%
0.00%
4.69%
0.010
32
Table 3
This table reports summary statistics of various variables, for sample firms. Sample firms consist of 129
firms that announced the expensing of stock options between July 2002 and December 2002. The table
reports the statistics separately for each group of sample firms based on the format in which the expensing
announcement was conveyed. Group 1 are firms that announced their decision to expense option via a
special press release that exclusively discussed the expensing issue. Group 2 contains firms that announced
the decision to expense in a press release that also discussed other issues (but not earnings). Group 3
announced the expensing of options within the earnings announcement press release. We did not find a any
announcement documents for firms in Group 4. Some financial press article discussing the expensing issue
was found for firms in group 5, although we did not track the original press release.
All variables are reported for the year 2001 or as of the end of that fiscal year, unless otherwise indicated.
The reported variables are: BM is the book-to-market ratio. Size is the market capitalization as of the
beginning of 2002. Revenues and total assets are reported in thousands of dollars. Size is market
capitalization in thousand. LEV is leverage measured as the ratio of total liabilities to total assets. PE is the
PE ratio. OPT_EXPENSE is the 2001 pro-forma option expense as reported in the stock options footnote
scaled by total assets. NIBEI is net income before extraordinary items deflated by lagged total assets. NI is
net income deflated by lagged total assets. CFO is cash flow from operations deflated by lagged total
assets. PCT_OUT is the percentage of shares held by outside directors (for most firms as of December
2002). PCT_IN is the percentage of shares held by insiders (for most firms as of December 2002). INST is
the percentage of shares held by institutions (for most firms as of December 2002). Publicity is the number
of articles appearing in Wall Street Journal for each firm during 2001. RET123 is the 3-day return around
January 21, 1992, the date in which FASB announced its intent to expense stock option compensation.
Some of the variables were not available for all firms.
Group 1
Group 2
Group 3
Group 4
Group 5
N
56
32
24
8
5
BM
0.48
0.48
0.51
0.42
0.56
Revenues
4,166
4,636
2,233
8,126
6,863
Total assets
8,249
14,968
3,617
69,402
69,896
Size
5,040
6,834
2,207
17,759
16,912
LEV
0.78
0.72
0.65
0.87
0.88
PE
20.97
17.12
17.78
16.87
35.10
OPT_EXPENSE
0.14%
0.09%
0.10%
0.08%
0.09%
NIBEI
0.02
0.03
0.03
0.02
-0.01
NI
0.02
0.03
0.03
0.02
0.01
CFO
0.07
0.09
0.08
0.01
0.06
PCT_OUT
0.23
0.17
0.44
0.07
0.05
PCT_IN
1.77
1.49
3.61
1.25
0.59
INST
55.0%
63.0%
57.5%
53.4%
70.3%
Publicity
5.50
6.00
2.50
6.50
40.00
RET123
0.90%
0.21%
2.71%
0.00%
-0.86%
33
Table 4
This table reports spearman (pearson) correlations on the upper-right (lower-left) part of the diagonals. All variables are reported for the year 2001 or as of the end of
that fiscal year, unless otherwise indicated. The reported variables are: BM is the book-to-market ratio. Size is the market capitalization as of the beginning of 2002.
Revenues and total assets are reported in thousands of dollars. Size is market capitalization in thousand. LEV is leverage measured as the ratio of total liabilities to
total assets. PE is the PE ratio. OPT_EXPENSE is the 2001 pro-forma option expense as reported in the stock options footnote scaled by total assets. NIBEI is net
income before extraordinary items deflated by lagged total assets. NI is net income deflated by lagged total assets. CFO is cash flow from operations deflated by
lagged total assets. PCT_OUT is the percentage of shares held by outside directors (for most firms as of December 2002). PCT_IN is the percentage of shares held
by insiders (for most firms as of December 2002). INST is the percentage of shares held by institutions (for most firms as of December 2002). Publicity is the
number of articles appearing in Wall Street Journal for each firm during 2001. RET123 is the 3-day return around January 21, 1992, the date in which FASB
announced its intent to expense stock option compensation. Some of the variables were not available for all firms.
Size
Size
BM
-0.391
PE
0.146
OPT_
EXP
-0.054
NI
0.140
NIBEI
0.137
CFO
0.105
LEV
0.267
Publici
ty
0.783
INST
0.029
PCT_
OUT
-0.476
PCT_I
N
-0.420
RET12
3
-0.003
-0.411
-0.449
-0.415
-0.425
-0.397
0.101
-0.318
-0.181
0.051
0.007
-0.028
0.366
-0.122
-0.136
0.060
-0.288
0.246
0.151
-0.049
0.044
-0.068
0.176
0.175
0.240
-0.574
0.084
0.267
0.112
0.217
0.004
0.982
0.629
-0.256
-0.122
0.181
-0.015
0.090
0.016
0.634
-0.254
-0.151
0.188
-0.012
0.088
0.003
-0.262
-0.097
0.159
0.023
0.053
-0.037
0.286
-0.177
-0.124
-0.278
0.017
0.062
-0.488
-0.491
0.138
-0.013
0.010
-0.052
0.273
0.053
BM
-0.152
PE
0.006
-0.020
OPT_EXP
-0.001
-0.221
0.186
NI
0.042
-0.164
-0.110
-0.232
NIBEI
0.040
-0.162
-0.108
-0.235
0.990
CFO
0.051
-0.243
-0.046
0.025
0.535
0.530
LEV
0.068
0.021
-0.079
-0.306
-0.066
-0.060
-0.191
Publicity
0.649
-0.126
-0.008
0.035
-0.050
-0.052
-0.089
0.209
INST
-0.060
-0.079
0.003
0.015
0.091
0.099
0.084
-0.120
-0.047
PCT_OUT
-0.068
-0.015
0.004
-0.007
0.004
0.011
0.019
0.022
-0.116
-0.076
PCT_IN
-0.099
-0.021
0.009
0.012
0.073
0.072
0.037
-0.163
-0.141
-0.029
0.024
RET123
-0.003
-0.041
-0.028
0.083
0.015
0.010
-0.035
0.004
0.022
0.018
0.071
34
-0.024
0.000
Table 5
This table reports results from logit regressions for the matched sample. Sample firms consist of 129 firms
that announced the expensing of stock options between July 2002 and December 2002. These were matched
to firms that did not announce expensing of stock options based on industry classification (SIC codes) and
market capitalization at the beginning of 2002.
All variables are reported for the year 2001 or as of the end of that fiscal year, unless otherwise indicated.
RET12 is the size-adjusted return on sample firms’ stock in the previous fiscal year. BM is the book-tomarket ratio. LN_SIZE is the market capitalization as of the beginning of 2002. LEV is leverage, the ratio of
total liabilities to total assets. OPT_EXPENSE is the 2001 pro-forma option expense as reported in the stock
options footnote scaled by total assets. NI is net income deflated by lagged total assets. OUT_DIR is the
percentage of outside directors. PCT_OUT is the percentage of shares held by outside directors (for most
firms as of December 2002). PCT_IN is the percentage of shares held by insiders (for most firms as of
December 2002). INST is the percentage of shares held by institutions (for most firms as of December 2002).
PUB is the log of the number of articles appearing in Wall Street Journal for each firm during 2001. RET123
is the 3-day return around January 21, 1992, the date on which FASB announced its intent to expense stock
option compensation. Some of the variables were not available for all firms.
Dependent Variable is an indicator variable which is equal to one if the firm announced its intention to
expense stock options and equals zero otherwise.
*,**,*** indicate statistical significance at the 10%, 5% and 1% levels, respectively.
Variable
Model 1
Model 2
Model 3
Model 4
N
210
210
203
144
Psuedo R2
0.04
0.08
0.11
0.16
-0.061
-0.054
0.839*
1.828***
(0.73)
(0.29)
(0.07)
(0.00)
-0.006
-0.325**
-0.292*
-0.188
RET12
Pred
-/+
Hypot.
2A,6
LN_SIZE
OPT_EXPENSE
-
5
(0.93)
(0.01)
(0.05)
(0.38)
-12.28*
-17.261**
-16.753**
-96.585*
(0.10)
(0.03)
(0.03)
(0.10)
BM
-0.000
-0.122
-0.218
-0.766
(0.99)
(0.75)
(0.60)
(0.38)
LEV
1.451**
1.388**
1.083
0.273
(0.02)
(0.03)
(0.11)
(0.79)
0.086
0.413
-0.199
2.963
NI
+
6
PUB
+
1
(0.00)
(0.01)
INST
?
7
-1.378*
-1.047
(0.08)
(0.31)
OUT_DIR
+
4
0.816
1.002
(0.38)
(0.46)
PCT_OUT
+
PCT_IN
-
RET123
+
(0.94)
(0.80)
(0.89)
(0.39)
0.506***
0.577***
0.516**
(0.00)
4
4
0.261
0.30
(0.12)
(0.16)
-0.004
-0.018
(0.78)
(0.47)
13.474**
3
(0.03)
35
Table 6
This table reports results from various logit regressions for the S&P sample. Sample firms consist of 129
firms that announced the expensing of stock options between July 2002 and December 2002. In addition the
sample consists of control firms in the S&P 1500 that did not announce expensing of stock options.
All variables are reported for the year 2001 or as of the end of that fiscal year, unless otherwise indicated.
RET12 is the size-adjusted return on sample firms’ stock in the previous fiscal year. BM is the book-tomarket ratio. LN_SIZE is the market capitalization as of the beginning of 2002. LEV is leverage, the ratio
of total liabilities to total assets. OPT_EXPENSE is the 2001 pro-forma option expense as reported in the
stock options footnote scaled by total assets. NI is net income deflated by lagged total assets. OUT_DIR is
the percentage of outside directors. PCT_OUT is the percentage of shares held by outside directors (for
most firms as of December 2002). PCT_IN is the percentage of shares held by insiders (for most firms as
of December 2002). INST is the percentage of shares held by institutions (for most firms as of December
2002). PUB is the log of the number of articles appearing in Wall Street Journal for each firm during 2001.
RET123 is the 3-day return around January 21, 1992, the date on which FASB announced its intent to
expense stock option compensation. Some of the variables were not available for all firms. DA_MJ is
abnormal accruals calculated using the modified-Jones model.
Dependent Variable is an indicator variable which is equal to one if the firm announced its intention to
expense stock options and equals zero otherwise.
*,**,*** indicate statistical significance at the 10%, 5% and 1% levels, respectively.
Variable
Model 1
Model 2
Model 3
N
1413
1007
654
Psuedo R2
0.16
0.16
0.19
0.142
-0.099
0.257
(0.47)
(0.77)
(0.53)
0.420***
0.150
0.078
(0.00)
(0.32)
(0.72)
-14.329
-15.681*
-185.51***
RET12
Pred
-
Hypot.
2A,6
LN_SIZE
OPT_EXPENSE
-
BM
?
5
LEV
6
(0.13)
(0.09)
(0.00)
0.402
-0.113
0.563
(0.32)
(0.78)
(0.46)
2.820***
2.526***
1.909*
(0.00)
(0.00)
(0.09)
1.558
2.206**
7.879**
(0.23)
(0.04)
(0.01)
0.535***
0.541**
NI
+
PUB
+
INST
?
7
-2.566***
OUT_DIR
+
4
(0.35)
(0.24)
(0.94)
PCT_OUT
+
-3.052
-3.087
-7.220
(0.52)
(0.59)
(0.43)
PCT_IN
-
1.398
1.369
1.745
(0.18)
(0.35)
RET123
+
3
DA_MJ
+
2B
1
4
4
(0.00)
(0.02)
-2.587***
-0.424
(0.00)
(0.00)
(0.679)
-0.629
-1.17\
-0.095
(0.41)
11.007***
(0.00)
36
-2.273*
-3.007
(0.09)
(0.20)
Table 7
Panels A and B report medians of the percentage change in the number of options granted by sample and
control firms to all employees and to the top 5 executives. The data for all employees is drawn from the
options footnotes in the financial statements for fiscal years 2001 and 2002. The data for the top 5
executives is extracted from Execucomp. The change is measured with respect to previous year. Panel C
reports changes to compensation plans taken from proxy statements of sample and control firms. We define
minor revisions to be changes that do not directly involve option-based compensation. Major changes
involve direct changes to option-based compensation and include total revisions to the entire compensation
plans as well as changes in mix between, for example, options and restricted stocks. Unclassified revisions
are changes whose nature we could not pinpoint.
Sample firms
N
Control firms
Median
N
Median
2001
Panel A:
Changes in options grants (All Employees)
113
3.23%
106
5.34%
2002
114
1.46%
-7.17%
108
2001
Panel B:
Changes in option grants (Top 5 executives)
81
0.0%
80
-5.5%
2002
51
-0.1%
-13.3%
54
Panel C:
Changes to compensation plans in proxy statements
N
Freq.
N
Freq
Minor revisions
25
23.4%
22
21.4%
Major revisions
30
28.0%
18
17.5%
Unclassified
Revisions
No revisions
6
5.6%
2
1.9%
46
43.0%
61
59.2%
Missing proxies
22
11
37
Marginal effects graphs for the matched sample
1
.9
.8
.7
probability
.6
.5
.4
.3
.2
.1
0
0
.05
.1
.15
.2
.25
opt_expense
.3
.35
.4
.45
.5
400
450
500
Figure 1A
1
.9
.8
probability
.7
.6
.5
.4
.3
.2
.1
0
0
50
100
150
200
250
publicity
Figure 1B
38
300
350
probability
Marginal effects graphs for the S&P sample
.05
.045
.04
.035
.03
.025
.02
.015
.01
.005
0
.05
0
.1
.15
.2
.25
.3
.35 .4 .45
opt_expense
.5
.55
.6
.65
.7
.75
.8
Figure 2A
.3
probability
.2
.1
0
0
50
100
150
200
Figure 2B
39
250
300
publicity
350
400
450
500