No full-text available
To read the full-text of this research,
you can request a copy directly from the authors.
Stock Option Expensing: Evidence from Shareholders' Votes
Abstract
In the 2003 and 2004 proxy seasons the Securities Exchange Commission allowed shareholders' proposals to expense employee stock options to be voted upon at the annual meeting. We analyze the determinants of shareholders' votes for a sample of 107 firms. We hypothesize and find that votes for expensing are higher in firms with perceived excessive option compensation and lower expected earnings impact from expensing. Insiders' ownership is positively associated to votes against, while most types of institutional investors tend to vote for expensing. Finally, votes for are higher in larger firms, with higher interest coverage, higher leverage and lower returns.
... Further, by directly studying the observable action of proxy voting by mutual funds, our results contribute to the debate of whether mutual funds serve as effective monitors and how their voting decisions impact the growing movement of increased shareholder activism. Several working papers have focused on the increased levels of submissions of shareholder resolutions and the subsequent success of some proposals on issues such as majority voting, declassifying the board, and expensing stock option (Cai, Garner, and Walking, 2006;Guo, Kruse, and Nohel, 2006;Ferri, Markarian, and Sandino, 2006). Our results suggest that mutual fund voting decisions may play an important role in the passage of these items. ...
... A number of recent papers examine some of these proposal types. For example, Cai, Garner, and Walking (2006) study proposals to adopt majority voting, Ferri, Markarian, and Sandino (2006) study proposals to expense stock options, Gine and Moussawi (2007) study proposals to repeal poison pills, and Guo, Kruse, and Nohel (2006) study proposals to declassify the board. Our results provide some background for this growing literature, and show that these issues indeed attract investor interest and, as we show later, garner support from mutual funds. ...
We address how mutual funds vote on shareholder proposals and identify factors that help determine support of wealth-increasing shareholder proposals. We examine 213,579 voting decisions made by 1799 mutual funds from 94 fund families for 1047 shareholder proposals voted on between July 2003 and June 2005. In an analysis of voting across funds within the same fund family, we find significant divergence in voting within families, emphasizing the importance of focusing on voting by individual funds. We also find that, in general, mutual funds vote more affirmatively for potentially wealth-increasing proposals and funds' voting approval rates for these beneficial resolutions are significantly higher than those of other investors. Our results suggest that funds tend to support proposals targeting firms with weaker governance. We also find that funds with lower turnover ratios and social funds are more likely to support shareholder proposals. Finally, fund voting approval rates significantly impact whether a proposal passes and whether one is implemented.
... ***, **, and * denote significant differences from zero at the 1, 5, and 10 % confidence levels 30 One might argue that shareholder proposals to vote on option expensing forced firms to expense options, and consequently affected pay-for-performance. However, our results are robust to excluding all firms with such shareholder proposals during the 2003 and 2004 proxy seasons (as identified in Table 1 in Ferri et al. (2006). pervasive during the pre-SOX years, likely for reasons other than overstatements (e.g., labor market competition and preservation of cash for further investments). ...
If overstatements were a symptom of the agency conflict, pay-for-performance sensitivities should have increased in response to the additional penalties for misreporting imposed by SOX. Our finding of their decrease is inconsistent with the view that overstatements were an unintended consequence of incentive pay prior to 2002. To corroborate our interpretation, we show that (i) CEO pay-for-performance sensitivities are higher among firms whose shareholders stand to benefit from overstatements; (ii) this cross-sectional relationship weakens significantly after SOX; and (iii) the within-firm decrease in pay-for-performance sensitivity is most pronounced among firms with high pre-SOX shareholder benefits from overstatements.
... Several other studies examine the stock market reactions to voluntary announcements of expensing stock options made by US firms (e.g. Aboody et al., 2004a; Ferri et al., 2005; Balsam et al., 2006; Bartov and Hayn, 2008). More recent studies (e.g. ...
This paper examines the market valuation of employee stock option expenses recognized by using the fair value approach under the Canadian Institute of Chartered Accounts Handbook section (CICA HB) 3870. Based on a sample of Canadian public firms traded on the Toronto Stock Exchange (TSX), we find that investors value employee stock option expenses differently prior to and after the implementation of the new standard. Specifically, pro forma compensation expenses disclosed prior to the new accounting regulation are negatively associated with annual stock returns, suggesting that the market interprets these expenses to have negative valuation consequences. In contrast, recognized stock option expenses from using the fair value approach mandated by the HB 3870 are positively associated with stock returns, indicating that the market now interprets these expenses as a type of "asset" that contributes positively to firm valuation. Overall, the evidence suggests that the mandatory expensing of employee stock options increases the perceived quality of financial statements and mitigates the perception that firms use stock options opportunistically. Consequently, the market is able to translate the incentive effect of employee stock options into firm value.
... A third group is focused on more specific tests to determine whether the financial market evaluates the companies that decide to recognise and the ones that only give disclosure in the same way. In general, recent researches (Aboody et al., 2004b;Semerdzhian, 2004;Robinson and Burton, 2004;Elayan et al., 2004;Seethamraju and Zach, 2004;Wallace, 2004;Deshmukh et al., 2004;Ferri et al., 2005) on that topic found out that companies that decide to recognise ESBPs on a voluntary basis with the aim of sending a signal on their credibility have been rewarded by the market. These companies are generally well-known in financial markets because of size and prestige and have a high percentage of long-term investors in their capital. ...
Many studies carried out on employee stock option plans state that the favourable accounting treatment, even if not declared, is often one of the main reasons for this form of compensation. This paper aims at determining whether there is an association between the granting of employee stock option plans and the adoption of earnings management practices aimed at improving the profit during the years when plans are issued. Our investigation uses the modified Jones model on a sample of Italian listed companies to study earnings management behaviour. This analysis can make a preliminary contribution to assess whether recognition required by IFRS 2 will imply a future reduction in the granting of stock options as incentive means. In fact, this accounting standard not only gives rise to a change in earnings figures and corporate disclosure, but could also force entities to revise their employee incentive policies. In such a perspective, it is reasonable to assume that the shift to IFRS 2 will lead companies that in the past issued stock option plans essentially for earnings management reasons to lessen the use of employee stock options.
... 84 expensing and 84 randomly selected nonexpensing firms during 2002. They report that firms with a high level of information asymmetry, as measured by dispersion of ownership, are more likely to adopt expensing in an effort to reduce information asymmetry. In addition, firms with lower option values in aggregate are more likely to adopt expensing. Ferri et al. (2004) examine the determinants of shareholder voting in a sample of 67 firms where a proposal for option expensing was submitted to a vote at the annual meeting. They find that votes in favor of expensing (1) increase when option-based compensation is perceived to be too high and when there is a lower expected impact on earnings from option e ...
During 2002 and 2003, 140 publicly traded US firms announced their intention to recognize an accounting expense when stock options are granted to employees. Many similar firms elected not to expense options. We study the stock market's reaction. There is no evidence whatsoever that expensing options reduces the stock price. To the contrary, around announcement dates, we find significant price increases for firms electing to expense options and significant price declines for industry/size/performance-matched firms that did not announce expensing at the same moment. The average relative change in market values is 3.65% during a 6 day window around the announcement. The magnitude of the market's reaction to expensing depends on agency costs, the magnitude of option expenses, and financial reporting costs. The market's reaction does not seem to be affected by contracting costs (e.g. induced by debt covenants), growth opportunities, or potential political repercussions. Moreover, the decision to expense and the magnitude of the market's reaction are not signals of future operating performance. The market seems to react favorably to transparent reporting while it penalizes firms that give the appearance of having something to hide.
... egarding the level of stock option-based compensation. For our study, the implication that the market already incorporates the valuation effects of stock option-based compensation as reported in the footnotes of the firm's annual reports suggests that the market should not, systematically, react negatively to the decision to recognize this expense. Ferri et al. (2004) examine the outcome of shareholder votes on the decision to begin voluntarily expensing stock option-based compensation . Their findings suggest that the voting outcome depends on the perceived excessive use of stock option compensation, the expected impact on earnings, and the stock ownership composition. These results imply that expen ...
This article is an historical analysis of the U.S. labor movement’s shareholder activism during the 2000s, which was based on their pension-plan assets. During the previous decade, corporate governance had tilted to give shareholders greater voice in corporate decisions. The protagonists were public pension plans such as CalPERS. Come the 2000s, they were replaced by unions and union-influenced pension plans. Their agendas overlapped but union investors were distinctive in their use of shareholder activism to make companies more public-minded, raise labor’s organizing power, and challenge executive power by reliance not only on shareholder activism but also political activities. Labor’s signature issue was executive pay, which was a topic that that shareholder activists during the 1990s had avoided other than to push for stock-based pay. But three waves of corporate scandals during the following decade caused other shareholders to become skeptical of executive pay-setting methods. Union investors zeroed in on expensing and backdating of stock options, and fought for say on pay, the issue where they had the greatest impact. An interaction between private orderings and regulation now developed, whereby shareholder pay reforms found their way into law. With inequality a major social concern, unions repeatedly contrasted lofty executive pay to stagnant wages. Yet little was said about lofty payouts to shareholders, which may have been a more important driver of inequality than executive pay. The article ties corporate governance to larger social and political developments in the U.S., and to the labor movement, embedding corporate governance in historical context.
This study investigates how the financial expertise of independent directors is associated with voluntary accounting policy decisions. As representatives of a company’s shareholders, financially-expert independent directors are more likely to cause management to pursue higher quality accounting policy decisions. The policy decision investigated involves the expense/non-expense policy choice for employee stock options as previously permitted under SFAS No. 123. Using a sample of 174 option-expensing firms and a matched control sample of 174 non-expensing firms, the results indicate a significant, positive association between the decision to expense employee stock options and the financial expertise of a company’s independent directors. Further, a significant, negative association was found between the option-expensing decision and whether the chief executive officer was the largest internal blockholder.
This research examines the valuation effect and the factors associated with firms' decisions to expense executive stock options, as well as determinants of market reaction to expensing announcements. The likelihood of expensing is found to be higher for firms subject to fewer agency problems and having a "share-holder friendly" corporate governance structure. These results suggest that the decision to expense is heavily influenced by the extent of discipline, monitoring, and how closely the interests of management and stockholders are aligned. The mean and median announcement-period returns are not found to be significantly different from zero. However, the post-announcement period abnormal returns are negative and statistically significant. The cross-sectional analysis provides support for the prediction that the market reaction to expensing has a differential valuation effect related to the level and structure of management compensation. Namely, companies with a higher percentage of long-term compensation (to total compensation) and a higher percentage of total compensation (to total assets) have negative, or less positive, average abnormal returns. These results are consistent with the first part of the argument advanced by the proponents of expensing options, that recognition causes reported earnings to decline and share prices to follow. The second part of their argument is that boards of directors will then be less inclined to grant excessive options is not supported. The perceived benefits (if capitalized in share price at announcement time) of the boards' action in terms of more transparency, is either absent or does not offset the negative impact of lower earnings and share prices of expensing firms.
I examine the likelihood of firms adopting the fair value based method of accounting for stock option compensation cost in 2002 and 2003. To examine this issue, I use two matched sample methodologies: (1) a size and book-to-market matching method typically employed in empirical accounting and finance research; and (2) a Propensity Score matching method typically used in the life sciences. I create a profile of firms that elected to expense employee stock option compensation when it was not yet required by Statement on Financial Standards No. 123 (Revised): Share-Based Payment (SFAS 123(R)). I find support for the general hypothesis that increasing switching costs from disclosure to recognition lowers the likelihood for stock option expense adoption in 2002 and 2003. More specifically, the likelihood of expensing stock options decreases when the magnitude of (implied) stock option expense increases and the value of options awarded to the firm's executives increases in relation to their total compensation. I find that the likelihood of expensing stock options increases when the interest coverage ratio increases and when the number of options awarded to the firm's executives increases in relation to the number of stock options awarded to all employees. I also find weak evidence that the likelihood of expensing is highest in the healthcare industry. Although these results hold under both matched sample approaches, the Propensity Score approach helps to prevent misleading statistical inference by reducing the bias inherent in traditional size and book-to-market matched sampling.
We examine the economic consequences of more than 150 shareholder proposals to expense employee stock options (ESO) submitted during the proxy seasons of 2003 and 2004, the first case in which the SEC allowed a shareholder vote on an accounting matter. Our results indicate that these proposals affected accounting and compensation choices. Specifically, (i) targeted firms were more likely to adopt ESO expensing relative to a control sample of S&P 500 firms, (ii) among targeted firms, the likelihood of adoption increased in the degree of voting support for the proposal, and (iii) non-targeted firms were more likely to adopt ESO expensing when a peer firm was targeted. Additionally, (i) CEO pay decreased in firms in which the proposal was approved relative to a control sample of S&P 500 firms, and (ii) among targeted firms, approval of the proposal was associated with decreases in CEO compensation and the use of ESO in CEO pay. Our findings reveal an increasing influence of shareholder proposals on governance practices.
The capitalization of research and development (R&D) costs is a controversial accounting issue because of the contention that such capitalization is motivated by incentives to manipulate earnings. Based on a sample of Italian listed companies, this study examines whether companies' decisions to capitalize R&D costs are affected by earnings-management motivations. Italy provides a natural context for testing our hypothesized relationships because Italian GAAP allows for the capitalization of R&D costs. Using a Tobit regression model to test our hypotheses, we show that companies tend to use cost capitalization for earnings-smoothing purposes. The hypothesis that firms capitalize R&D costs to reduce the risk of violating debt covenants is not supported.
I develop a corporate governance framework, provide a broad overview of recent corporate governance research, and place each of the Special Issue papers within the context of this framework. The papers in the issue contribute to our understanding of a wide range of governance topics including: the role of antitakeover measures, board structure, capital market governance, compensation and incentives, debt and agency costs, director and officer labor markets, fraud, lawsuits, ownership structure, and regulation. In short, the papers span almost every aspect of governance systems.
This paper provides evidence that uncontested director elections provide informative polls of investor perceptions regarding board performance. We find that higher (lower) vote approval is associated with lower (higher) stock price reactions to subsequent announcements of management turnovers. In addition, firms with low vote approval are more likely to experience CEO turnover, greater board turnover, lower CEO compensation, fewer and better-received acquisitions, and more and better-received divestitures in the future. These findings hold after controlling for other variables reflecting or determining investor perceptions, suggesting that elections not only inform as a summary statistic, but incrementally inform as well.
ResearchGate has not been able to resolve any references for this publication.