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The Accuracy of Disclosures for Complex Estimates: Evidence from Reported Stock Option Fair Values

54 Pages Posted: 7 Feb 2015 Last revised: 22 Jul 2016

Brian Bratten

University of Kentucky - Von Allmen School of Accountancy

Ross Jennings

University of Texas at Austin - Department of Accounting

Casey M. Schwab

Indiana University - Kelley School of Business - Department of Accounting

Date Written: July 1, 2015

Abstract

In this study, we exploit the unique reporting requirements for employee stock options to provide large sample evidence on the accuracy of footnote disclosures related to a specific complex estimate, the fair value of options granted. We first document the frequency and magnitude of differences between (1) the reported weighted-average fair value of options granted and (2) the calculated option fair value using the disclosed weighted-average valuation model inputs and the Black-Scholes option pricing model. In a sample of 23,358 firm-year observations between 2004 and 2011, we find that 23.9 percent have reported and calculated option fair values that differ by more than ten percent, and that these differences are sticky and are frequently significant as a percentage of net income. We also find that fair value differences are larger for firms that (1) exhibit anomalous stock option footnote disclosures that likely result from disclosure errors, (2) have more complex and hence error-prone stock option programs, and (3) have lower quality financial reporting. Taken together this evidence is consistent with large fair value differences that are primarily due to unintentional errors in the stock option footnote disclosures. To document the consequences of these fair value differences, we provide evidence that errors in the reported fair values prevent financial statement users from using the reported values to reliably estimate future stock option expense for many firms. Consistent with this result, we also find that analyst forecasts are less accurate and more disperse for firms with larger fair value differences.

Keywords: Employee stock options, fair values, disclosure quality, complex estimates

JEL Classification: M41

Suggested Citation

Bratten, Brian and Jennings, Ross and Schwab, Casey M., The Accuracy of Disclosures for Complex Estimates: Evidence from Reported Stock Option Fair Values (July 1, 2015). Accounting, Organizations and Society, Vol. 52, pp. 32-49, 2016. Available at SSRN: https://ssrn.com/abstract=2560885 or http://dx.doi.org/10.2139/ssrn.2560885

Brian Bratten

University of Kentucky - Von Allmen School of Accountancy ( email )

Lexington, KY 40506
United States

Ross Jennings (Contact Author)

University of Texas at Austin - Department of Accounting ( email )

Austin, TX 78712
United States
512-471-5340 (Phone)
512-471-3904 (Fax)

Casey M. Schwab

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

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