Employee Stock Option Fair-Value Estimates: Do Managerial Discretion and Incentives Explain Accuracy?
Leslie D. Hodder
Indiana University Bloomington - Department of Accounting
William J. Mayew
Duke University - Fuqua School of Business
Mary Lea McAnally
Texas A&M University - Department of Accounting
Connie D. Weaver
Texas A&M University
Contemporary Accounting Research, Vol. 23, No. 4, Winter 2006
We examine the determinants of managers' use of discretion over employee stock option (ESO) valuation-model inputs that determine ESO fair values. We also explore the consequences of such discretion. Firms exercise considerable discretion over all model inputs and this discretion results in material differences in ESO fair-value estimates. Contrary to conventional wisdom, we find that a large proportion of firms exercise value-increasing discretion. Importantly, we find that the use of discretion improves predictive accuracy for about half of our sample firms. Moreover, we find that both opportunistic and informational managerial incentives together explain the accuracy firms' ESO fair value estimates. Partitioning on direction of discretion improves our understanding of managerial incentives. Our analysis identifies that financial statement readers can use mandated contextual disclosures to construct powerful ex ante predictions of ex post accuracy.
Keywords: Employee stock options, Black-Scholes, managerial discretion, accounting contextual disclosures
JEL Classification: M41, M45, J33, G30, G13Accepted Paper Series
Date posted: July 14, 2006
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