Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R

Authors

  • PREETI CHOUDHARY,

    1. Georgetown University, McDonough School of Business
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  • SHIVARAM RAJGOPAL,

    1. University of Washington Business School
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  • MOHAN VENKATACHALAM

    1. Fuqua School of Business, Duke University. We thank an anonymous referee, Raj Aggarwal, Merle Erickson (editor), Jennifer Francis, Jon Glover, Rebecca Hann, Ross Jennings, Chandra Kanodia, Bill Kinney, Bill Mayew, Ed Maydew, Partha Mohanram, Kevin Murphy, Karen Nelson, Doron Nissim, Terry Shevlin, Scott Taub, Ross Watts, Greg Waymire, Joe Weber, and workshop participants at the 2006 FARS Conference, Columbia University, Massachusetts Institute of Technology, University of California–Berkeley, University of Minnesota, University of Southern California, University of Texas at Austin, UNC/DUKE Fall Camp, and the American Accounting Association meetings in 2006 and 2007 for many helpful suggestions on the paper. We are grateful to Katherine Schipper for many helpful discussions. We thank Carl Schmitt of Buck Consultants and Jack Cieselski of the Analyst's Accounting Observer for sharing their data with us and Xin Wang for research assistance. We acknowledge financial support from the University of Washington Business School, Fuqua School of Business, and Global Capital Markets Center, Duke University.
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ABSTRACT

In December 2004, the Financial Accounting Standards Board (FASB) mandated the use of a fair value–based measurement attribute to value employee stock options (ESOs) via Financial Accounting Standard (FAS) 123-R. In anticipation of FAS 123-R, between March 2004 and November 2005, several firms accelerate the vesting of ESOs to avoid recognizing existing unvested ESO grants at fair value in future financial statements. We find that the likelihood of accelerated vesting is higher if (1) acceleration has a greater effect on future ESO compensation expense, especially related to underwater options, and (2) firms suffer greater agency problems, proxied by fewer blockholders, lower pension fund ownership, and top five officers holding a greater share of ESOs. We also find a negative stock price reaction around the announcement of the acceleration decision. Furthermore, stock returns are significantly negative before the new vesting dates and positive afterward, suggesting that vesting dates could have been backdated.

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