Expensing Executive Stock Options: The Agency Problem and Structure of Management Compensation

42 Pages Posted: 30 Jun 2007

See all articles by Fayez A. Elayan

Fayez A. Elayan

Brock University-Goodman School of Business

Thomas O. Meyer

Southeastern Louisiana University - Department of Marketing and Finance

Jennifer Li

Brock University

Date Written: 2007

Abstract

This research examines the valuation effect and the factors associated with firms' decisions to expense executive stock options, as well as determinants of market reaction to expensing announcements. The likelihood of expensing is found to be higher for firms subject to fewer agency problems and having a "share-holder friendly" corporate governance structure. These results suggest that the decision to expense is heavily influenced by the extent of discipline, monitoring, and how closely the interests of management and stockholders are aligned.

The mean and median announcement-period returns are not found to be significantly different from zero. However, the post-announcement period abnormal returns are negative and statistically significant. The cross-sectional analysis provides support for the prediction that the market reaction to expensing has a differential valuation effect related to the level and structure of management compensation. Namely, companies with a higher percentage of long-term compensation (to total compensation) and a higher percentage of total compensation (to total assets) have negative, or less positive, average abnormal returns.

These results are consistent with the first part of the argument advanced by the proponents of expensing options, that recognition causes reported earnings to decline and share prices to follow. The second part of their argument is that boards of directors will then be less inclined to grant excessive options is not supported. The perceived benefits (if capitalized in share price at announcement time) of the boards' action in terms of more transparency, is either absent or does not offset the negative impact of lower earnings and share prices of expensing firms.

Keywords: Stock Options, Expensing, Compensation, Recognition

JEL Classification: G12, G34, M41, M44, J33

Suggested Citation

Elayan, Fayez A. and Meyer, Thomas Otto and Li, Jingyu, Expensing Executive Stock Options: The Agency Problem and Structure of Management Compensation (2007). Available at SSRN: https://ssrn.com/abstract=987698 or http://dx.doi.org/10.2139/ssrn.987698

Fayez A. Elayan (Contact Author)

Brock University-Goodman School of Business ( email )

1812 Sir Issac Brock Way
St. Catharines, Ontario L2S 3A1
Canada
905-688-5550 (Phone)
905-688-9779 (Fax)

HOME PAGE: http://www.brocku.ca

Thomas Otto Meyer

Southeastern Louisiana University - Department of Marketing and Finance ( email )

SLU 10844
Hammond, LA 70402
United States
985-549-3103 (Phone)
985-549-5010 (Fax)

Jingyu Li

Brock University ( email )

500 Glenridge Avenue
St. Catherines, Ontario L2S 3A1
Canada

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