The Valuation Implications of Employee Stock Option Accounting for Profitable Computer Software Firms

Posted: 19 Jun 2002

See all articles by Timothy B. Bell

Timothy B. Bell

KPMG International, LLP - Assurance & Advisory Services Center

Wayne R. Landsman

University of North Carolina Kenan-Flagler Business School

Bruce L. Miller

University of California, Los Angeles (UCLA) - Accounting Area

Shu Yeh

KPMG LLP, Montvale

Abstract

We use the Ohlson (1995, 1999) and Feltham-Ohlson (1999) valuation models to compare the extent to which Accounting Principles Board Opinion 25: Accounting for Stock Issued to Employees (APB 25), Statement of Financial Accounting Standards No. 123: Accounting for Stock-Based Compensation (SFAS 123), and the Exposure Draft: Accounting for Stock-Based Compensation reflect the market's assessment of the effects of employee stock options on firm value for a sample of 85 profitable computer software firms. Findings from the SFAS 123 approach indicate the market appears to value ESO expense not as an expense but as an asset. Most notably, the results suggest that investors perceive that employee stock options create an intangible asset that they value more highly than other assets of the firm. The Exposure Draft approach, according to our findings, best captures the market's perception of the economic effect of employee stock options (ESO) on firm value for profitable computer software companies. However, we find a conflict in (1) the positive manner in which investors appear to value ESO expense, and (2) the negative relation between current ESO expense and future abnormal earnings. This conflict could be a an artifact of the restrictiveness of the abnormal earnings forecasting equation we estimate, although it also calls into question whether investors in profitable software companies assess correctly the effect of ESOs on profitable software firms value.

JEL Classification: M41, M44, G12, G32, J33

Suggested Citation

Bell, Timothy B. and Landsman, Wayne R. and Miller, Bruce Leonard and Yeh, Shu, The Valuation Implications of Employee Stock Option Accounting for Profitable Computer Software Firms. Available at SSRN: https://ssrn.com/abstract=316524

Timothy B. Bell

KPMG International, LLP - Assurance & Advisory Services Center ( email )

300 Tice Bouldevard
Woodcliff Lake, NJ 87675
201-505-2006 (Phone)

Wayne R. Landsman (Contact Author)

University of North Carolina Kenan-Flagler Business School ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States
919-962-3221 (Phone)
919-962-4727 (Fax)

Bruce Leonard Miller

University of California, Los Angeles (UCLA) - Accounting Area ( email )

D410 Anderson Complex
Los Angeles, CA 90095-1481
United States
(310) 825-1814 (Phone)

Shu Yeh

KPMG LLP, Montvale ( email )

Montvale Executive Office
Three Chestnut Ridge Road
Montvale, NJ 07645-0435
United States

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