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The determinants of the dramatic increase in the use of employee stock options in the 1990s and the subsequent decline in their popularity have been the subject of intense debate. Some have argued and found evidence to support that the discretion granted to firms to avoid recognizing the fair value of options as an expense led to their overuse for employee compensation. Others have argued and found evidence that the market “sees through” the accounting treatment for options and values firms as though options were expensed at fair value, regardless of financial statement treatment. We revisit this issue with the benefit of post-SFAS 123R data and the addition of controls for key economic and labor market factors that prior research has shown to influence option grants. Our analysis focuses on non-executive options, as such grants comprise almost 90% of employee option grants. We follow Carter et al. (2007) in measuring firm-level propensity to avoid expense recognition (financial reporting concerns). We do not find an association between financial reporting concerns and employee option grants after controlling for the relevant economic/labor market factors. Our analysis of change in option use over 1995-2007 shows that changes in option grants are associated with corresponding changes in economic determinants. Finally an examination of change in option use subsequent to the mandatory adoption of SFAS 123R shows that firms with a higher level of reporting concerns prior to adoption experienced a comparable reduction in options relative to firms with a lower level of reporting concerns. Overall, the results suggest that the role of accounting in influencing employee option grants has likely been overstated, and the dead-weight economic costs from overuse of options appear to be less than widely perceived.

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Accounting | Business


46 pages


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