Excessive Discretion or Information Transmission? Evidence from Option Valuation Reporting

Abstract

Mandatory reports of stock option valuation parameters involve expectations about the future, so that there is not just one justifiable value for each parameter. To delineate a set of justifiable reported parameter values, we rely on FASB (Financial Accounting Standards Board) guidance. Even though the FASB provides very clear guidelines in that regard, we find that firms report a riskfree rate that does not comply with FASB guidance in 12.5% of cases, regardless of the assumptions made about the relevant riskfree rate. We apply a similar methodology to other firm-specific stock option valuation parameters (the stock's volatility rate and the dividend yield) that takes into account that the FASB allows for flexibility in choosing the reported values of these parameters. We find that a substantial minority of firms engage in reporting that involves deviations from a range of ``justifiable'' measures that can be computed with publicly available data. However, additional analyses show that even those reports tend to be positively related to future realizations of these variables (the stock's volatility rate and the dividend yield) even after controlling for other factors. This provides evidence of legitimate deviations from prescribed financial reporting standards.

Keywords: disclosure, dividend yield, executive stock option, fair measurement, manipulation, volatility

JEL Classification: M41, M42, M12, G35