The Effect of Expensing Stock Options on Corporate Earnings
2004; Allied Academies; Volume: 8; Issue: 2 Linguagem: Inglês
ISSN
1096-3685
AutoresTricia Coxwell Snyder, M. Gritsch,
Tópico(s)Auditing, Earnings Management, Governance
ResumoABSTRACT The increase in stock option grants is becoming increasingly controversial as disclosures emerge that senior executives of companies such as Enron Corp. have abused the exercising of their stock options. Currently, the SEC does not require that compensation expenses be reported on the income statement for stock option plans, allowing stock options, unlike other forms of compensation, to not be considered a business expense, meaning that they are not deducted from earnings. This policy creates an accounting incentive to pay executives with stock option compensation, which potentially allows companies to over-value their reported earnings. To examine if current accounting standards encourage firms to issue stock options as a form of CEO compensation to over inflate earnings, we use repeated cross-sectional data from Standard & Poor's ExecuComp annual data set on 2,412 firms from 1992 to 2000 on the CEO of a firm. We find that the extent to which reported earnings are exaggerated increased during the 1990s. This is true for absolute dollar figures as well as relative to a firm's net earnings. We also determine the degree to which firm size plays into the effects. Results suggest that firms, on average, over-inflated reported earnings by 5.1 percent. However, earnings can be over-inflated by as much as 13.6 percent for small companies. INTRODUCTION The 1990s increase in stock option grants is becoming increasingly controversial as disclosures emerge that CEOs of companies such as Enron Corp. and Global Crossing reaped millions of dollars in profit by exercising their stock options as the public held onto stock that became worthless. In 2000, the Enron Chairman, Kenneth Lay realized 123.4 million in exercised stock options. Similarly, the CEO of Global Crossing, Mr. Annunziata, received 182 million dollars worth of stock options, while the company reported a negative net income of $10,500,000. If Enron and Global Crossing had incorporated stock options as a business expense it would have greatly reduced their operating profit for the year; reducing Enron earnings by close to 10%. Similarly, if Oracle and Citicorp had incorporated stock options as a business expense in 2000, it would have reduced their operating profit by over $900 million. In fact, if firms reported stock options as a business expense the following companies are just a few of the firms that would not have reported a profit in 2000: Broadcom, Parametric Technology, Novell, Yahoo, BMC Software, Network Appliance, Conexant Systems, Citrix Systems, Mercury Interactive, Peoplesoft, Sapient, Siebel Systems, McKesson and Quintiles Transnational (see Bear Stearns, Wall Street Journal, March 26, 2002.) In addressing the current scandals of Enron and Global Crossing, Federal Reserve Chairman, Greenspan stated to the House and the Senate in March 2002 that ..companies should be required to treat grants of stock options as any other expense, reducing the profits they report to shareholders when they issue options just as they do when they pay executives in cash. Greenspan, as well as several members of Congress, suggests that counting stock options as a business expense generates income neutrality between all forms of compensation. Similarly, Senator Carl Levin recently suggested that stock option pay encourages firms to push the accounting rules to the limit, which might have severe consequences for the stability of our economy. In contrast, President Bush opposes this view and believes that stock options should not be treated as a corporate expense. He, along with many businesses, believe that counting options as a business expense would confuse corporate earnings figures, take away an employee's stake in the company, and limit young, smaller companies' ability to raise capital. In response to this heated debate, the Financial Accounting Standard Board (FASB) is requesting comment on whether all companies should be made to expense stock options. …
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