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Abstract:
We investigate the determinants and consequences of the changes in option-based compensation for the top five executives around the issuance of SFAS 123R. We find that the reduction in the proportion of total compensation paid in employee stock options (ESOs) increases in (1) the firm's tendency to take advantage of ESO's favorable accounting treatment to report higher earnings in the pre-expensing period (as proxied by debt contracting concerns, pressure to meet or beat earnings benchmarks and corporate governance strength); and (2) the amount of ESO expense to be recognized upon adopting SFAS 123R (as proxied by the values of annual ESO grants and unvested outstanding ESOs pre SFAS 123R). Our findings are consistent with ESOs' favorable accounting treatment prior to SFAS 123R having a significant effect on boards' executive compensation decisions. We show that firms were more likely to replace ESOs with restricted stock but not with other forms of compensation post SFAS 123R. The substitution between restricted stock and ESOs, however, was far less than dollar for dollar, and that ESO cutbacks around the issuance of SFAS 123R resulted in reduced abnormal compensation.

Employee stock options, SFAS 123R, Executive compensation

Abstract:
Financial Accounting Standard No. 130 "Reporting Comprehensive Income" encourages enterprises to report comprehensive income on a performance statement rather than on a statement of equity. We investigate the reporting decisions of 82 publicly traded property-liability insurers, which are fairly evenly split in their choice. We find that insurers with a tendency to manage earnings through realized securities' gains and losses (i.e., cherry pickers), as well as insurers with a reputation for poor financial reporting quality, are more likely to bury comprehensive income in a statement of equity. Apparently, these insurers face the highest cost of transparency. Our findings that insurers' comprehensive income reporting choices are a reflection of their proclivity toward cherry picking as well as their level of financial reporting quality should be of interest to standard setters because of the controversy over standard setters' preference for mandating all firms to report comprehensive income in a performance statement.

Abstract:
We investigate the causes and consequences of changes in option-based compensation for the top five executives around the issuance of SFAS 123R, which requires firms to expense the fair value of their employee stock options (ESOs) on their income statements. We hypothesize that firms with greater tendencies to substitute ESOs for other forms of compensation to report higher earnings pre SFAS 123R cut back more on ESOs. Consistent with our hypotheses, we find that reduction in the proportion of total compensation paid in ESOs increased in the firm's propensity to take advantage of ESOs' favorable accounting as proxied by debt contracting concerns, tendency to achieve earnings benchmarks using ESOs' favorable accounting treatment, corporate governance weakness, and if the firm accelerated vesting of outstanding ESOs in response to SFAS 123R. We show that firms replaced ESOs with restricted stock post SFAS 123R, but the substitution was less than dollar for dollar. We also find that ESO cutbacks around the issuance of SFAS 123R reduced abnormal compensation without harming firms' operating performance.

Employee stock options, SFAS 123R, Executive compensation

Abstract:
We provide evidence that the market prices a firm’s earnings performance, i.e., success or failure with respect to earnings expectations, conditionally on the current state of its industry’s earnings performance. Specifically, we find that both positive price responses to performance successes and negative price responses to failures are increasing in the industry success rate. This pricing appears rational in the sense that conditioning a firm’s current earnings performance on the industry state is informative regarding the firm’s future performance. Our contribution is to reveal the current pricing and future earnings implications of interpreting earnings performance on a relative basis.

Earnings expectations, intra-industry, market reaction, earnings performance

Abstract:
We investigate whether the firm's corporate governance affects the value of equity grants for its CEO. Consistent with the managerial power view, we find that firms with poorer corporate governance grant their CEOs higher values of equity compensation after controlling for the economic determinants of these grants. We show that the negative relation between governance strength and equity compensation cannot be attributed to either omitted economic factors or the substitution effect between governance strength and incentive compensation. As further evidence consistent with the managerial power view, we show that firms with poorer governance in the pre-Enron era cut back more on the use of employee stock options (ESOs) for their CEOs in the post-Enron era, a period when CEO compensation received intensified public scrutiny and when the transparency and accounting cost of ESOs increased. We show that the association between governance strength and abnormal equity compensation remains significantly negative even after controlling for the divergence between the subjective and fair values of equity compensation.

corporate governance, executive compensation, stock options

Abstract:
This paper examines whether outstanding employee stock options (ESOs), which represent the firm's contractual obligation to deliver shares upon ESO exercise, affect firms' credit ratings. I hypothesize that outstanding ESOs play two information roles - (1) suggesting equity infusion; and (2) predicting share repurchases - that help credit rating agencies evaluate the issuing company's debt service ability. Consistent with these hypothesized roles, results indicate that the present values of expected cash proceeds and tax benefits from ESO exercise have favorable effects on credit ratings. In contrast, the present value of the expected cost of ESO-related share repurchases has an unfavorable effect on credit ratings and this unfavorable effect is more pronounced for firms with a greater tendency to repurchase shares. The after-tax fair value of outstanding ESOs, which summarizes the effects of the above three ESO-related cash flows, is negatively associated with credit ratings. Taken together, these findings are consistent with credit rating agencies incorporating the information conveyed by outstanding ESOs regarding potential equity infusion and ESO-related repurchases in their credit risk assessments and assigning lower credit ratings to firms with greater values of outstanding ESOs.

employee stock options, SFAS 123R, credit ratings

Abstract:
Financial Accounting Standard No. 130 Reporting Comprehensive Income encourages enterprises to report comprehensive income on a performance statement rather than on a statement of equity. We investigate the reporting decisions of 82 publicly traded property-liability insurers, which are fairly evenly split in their choice. Our results demonstrate that insurers with a tendency to manage earnings through realized securities' gains and losses (i.e., cherry pickers), as well as insurers with a reputation for poor disclosure quality, are more likely to report comprehensive income in a statement of equity. Apparently, these insurers face the highest cost of transparency. We do not find a relation between the reporting decision and the volatility of comprehensive income relative to the volatility of net income. Our findings that insurers' comprehensive income reporting choices are a reflection of their proclivity toward cherry picking as well as their level of disclosure quality should be of interest to standard setters because of the controversy over standard setters' preference for mandating all firms to report comprehensive income in a performance statement.

comprehensive income, accounting choice, property-liability insurers, earnings management