Changes in Option-Based Compensation Around the Issuance of SFAS 123R

Authors

  • Lawrence D. Brown,

    1. The authors are respectively from Georgia State University and National Taiwan University. They gratefully acknowledge the comments of an anonymous referee, Peter Pope (editor), Ashiq Ali, Eli Bartov, Dan Collins, Christi Gleason, Paul Healy, Tom Lys, Maria Nondorf, Shiva Rajgopal, Doug Skinner, Abbie Smith, Franco Wong, and workshop participants at the 2007 American Accounting Association Annual Meetings, 2007 Harvard University IMO Conference, 2007 University of Okalahoma Accounting Research Conference, Georgia State University, National Taiwan University, University of Iowa, and University of Texas at Dallas for helpful comments. Yen-Jung Lee thanks Taiwan National Science Council and National Taiwan University College of Management for financial support.
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  • Yen-Jung Lee

    Corresponding author
    1. The authors are respectively from Georgia State University and National Taiwan University. They gratefully acknowledge the comments of an anonymous referee, Peter Pope (editor), Ashiq Ali, Eli Bartov, Dan Collins, Christi Gleason, Paul Healy, Tom Lys, Maria Nondorf, Shiva Rajgopal, Doug Skinner, Abbie Smith, Franco Wong, and workshop participants at the 2007 American Accounting Association Annual Meetings, 2007 Harvard University IMO Conference, 2007 University of Okalahoma Accounting Research Conference, Georgia State University, National Taiwan University, University of Iowa, and University of Texas at Dallas for helpful comments. Yen-Jung Lee thanks Taiwan National Science Council and National Taiwan University College of Management for financial support.
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Yen-Jung Lee, National Taiwan University, College of Management, 1 Roosevelt Road, Sec. 4, Taipei, Taiwan 10617. 
e-mail: ylee@ntu.edu.tw

Abstract

Abstract:  We investigate the extent to which employee stock option (ESO) cutbacks around issuance of SFAS 123R are explained by eliminating the favorable accounting treatment available to firms prior to SFAS 123R and the economic consequences of such ESO cutbacks. We find a reduction in the grant day fair value of ESOs to all employees, which is an increasing function of the accounting benefits the firm derived from ESOs’ favorable accounting treatment prior to SFAS 123R. The removal of these accounting benefits explains 20% (45%) of ESO cutbacks around the issuance of SFAS 123R for our sample median (mean) firm. We do not find that firms cutting back more on the use of ESOs experienced a greater decrease in firm performance. Rather, a dollar increase in ESOs is associated with higher future productivity and higher future firm value in the post-SFAS 123R period. Collectively, our evidence suggests that ESOs’ favorable accounting treatment prior to SFAS 123R provided firms with incentives to make compensation decisions that minimized accounting expense but did not maximize firm value. We show that firms were more likely to replace ESOs with restricted stock and long-term incentive plans post-SFAS 123R but the substitution was far less than dollar for dollar.

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