Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R
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Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R
Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-RPreeti choudharyDoctoral StudentFuqua School of Business, Duke UniversityP.O Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-RO. Box 90120. Durham. NC 27708Tel: 919 660 7906; Fax: 919 660 7971 email: pc27@duke.eduShivaram Rajgopal Herbert o. Whitten Endowed Professor University of Washington Business School Box 353200, Seattle, WA 98195 Tel. 206 543 7913; Fax 206 685 9392 email: rajgopal@u.washington.eduMohan Venkatachalam Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R* Associate Professor Fuqua School of Business, Duke University P.O. Box 90120, Durham, NC 27708 Tel: 919 660 7859; Fax: 919 660 7971 email: vmohan@duAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R
ke.edu39083Abstract:The Financial Accounting Standards Board (FASB) recently mandated the use of a fair value based measurement attribute to value empAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-RPreeti choudharyDoctoral StudentFuqua School of Business, Duke UniversityP.O Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R ESOs to avoid recognizing existing ESO grants at fair value in future financial statements. We find that the likelihood of accelerated vesting is higher if (i) acceleration has a greater effect on future ESO compensation expense, especially related to underwater options; and (ii) firms suffer great Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-Rer agency problems, proxied by fewer block-holders, lower pension fund ownership and top five officers holding a greater share of ESOs. We also find aAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R
negative stock price reaction around the announcement of the acceleration decision, especially for firms with greater agency problems.♦Corresponding Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-RPreeti choudharyDoctoral StudentFuqua School of Business, Duke UniversityP.O Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-Raren Nelson, Doron Nissim, Terry Shevlin, Ross Watts, Greg Waymire, Joe Weber and workshop participants at the 200G FARS Conference, Columbia University, Massachusetts Institute of Technology. University of California. Berkeley. University of Minnesota. University of Southern California, University Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-Rof Texas at Austin and UNC'DUKE Fall Camp for many helpful suggestions on the paper. We are grateful to Katherine Schipper for many helpful discussionAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R
s. We thank Carl Schmitt of Buck Consultants and Jack Cieselski of the Analyst’s Accounting Observer for sharing their data with us and thank Xin WangAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-RPreeti choudharyDoctoral StudentFuqua School of Business, Duke UniversityP.O Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-Rsity.Accelerated Vesting of Stock Options in Anticipation of FAS 123-R1. IntroductionIn March 31. 2004. the Financial Accounting Standards Board (FASB) issued an exposure draft followed by a formal standard. FAS 123-R. on December 12. 2004 that required the use of a fair value based measurement appr Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-Roach for share based payments, including employee stock options (ESOs), effective June 15. 2005. Public firms were required to apply the new accountinAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R
g rules to (i) all ESO awards granted after June 15. 2005: and (ii) ESO awards granted after 1994 but not vested as of June 15. 2005. The fair value bAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-RPreeti choudharyDoctoral StudentFuqua School of Business, Duke UniversityP.O Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-Rh new option grants and existing unvested options. In order to reduce or avoid financial reporting costs associated with FAS 123-R firms could consider two (not mutually exclusive) alternatives. With regard to compensation expense arising from (i) above, firms could avoid issuing new option grants a Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-Rfter the effective date, i.e., June 15, 2005; with respect to (ii) above, firms could consider vesting all unvested options (i.e.. accelerate the vestAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R
ing) prior to the effective date. In this paper we focus on accelerated vesting because it represents a short term, one time response to an accountingAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-RPreeti choudharyDoctoral StudentFuqua School of Business, Duke UniversityP.O Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R vesting decision is motivated by extant research that indicates managers take "real" actions in response to accounting standards to avoid or achieve a financial reporting outcome. Real managerial actions could also result in wealth transfers either to or away from firm shareholders. For example. Mi Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-Rttelstaedt. Nichols and Regeir (1995) report that a significant number of firms cut health care benefits after the passage of SFAS 106 which requiredAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R
financial statement recognition of health care costs. Health care benefit reductions represent wealth transfers away from employees to shareholders. IAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-RPreeti choudharyDoctoral StudentFuqua School of Business, Duke UniversityP.O Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-Rtivity surrounding a 19981 The SEC postponed the Implementation date of FAS 123-R by six months for calendar year companies. However, this postponement will not affect firms whose fiscal year ends after June 15*. Our sample ends with accelerated vesting announcements as of November 18, 2005 to allow Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R enough time for data gathering and analysis.2FASB proposal that changed the accounting for option repricings. Ill this FASB proposal, linns that reprAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R
ice stock options alter December 15, 1998 would record a compensation expense ecpial Io the difference lielween the new exercise price and the market Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-RPreeti choudharyDoctoral StudentFuqua School of Business, Duke UniversityP.O Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-Rantly during 12 clays prior to the effective dale, indicative of managers taking advantage ol ac counting rille changes Io transfer wealth from shareholders Io employees and themselves. Our study complements Carter and Lyne h (2003) by examining accelerated oplion vesting, a real action in response Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-Rto an at counting standard that benefits the employees at shareholder’s expense. However, our researc h differs from theirs in three ways. First, in tAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R
he repricing setting, there was no financial rejxiriing consequence for firms’ past actions (i.e.. prior option grants) or for firms that did not findAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-RPreeti choudharyDoctoral StudentFuqua School of Business, Duke UniversityP.O Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R. In the accelerated vesting setting, firms that do not accelerate the vesting of unvested options (i.e.. do nothing), would still face a financial reporting cost. Second, unlike the repricing setting where the financial effects are not estimable due to unknown future prices, we are able to quantify Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R the financial reporting costs for both accelerators and non-accelerators. Consequently, we are able to document that the accelerated vesting decisionAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R
is influenced by the level of financial reporting costs. Lastly, we are able to quantify the wealth transfer from shareholders to employees through tAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-RPreeti choudharyDoctoral StudentFuqua School of Business, Duke UniversityP.O Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-Rgate what motivates some films to alter their compensation contracts in response to an accounting standaid. while others do not. In other words, we examine the characteristics of films that accelerate the vesting of options prior to the effective date of I AS 123-R to evaluate the cost benefit trade Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-Roff associated with the acceleration decision, while the timing of the accelerated vesting decision suggests that it is driven by financial reportingAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R
benefits, there are other reasons Io accelerate option vesting, including economic motivations such as (i) hastening the inflow ol c ash from option eAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-RPreeti choudharyDoctoral StudentFuqua School of Business, Duke UniversityP.O Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R managers due to poor3governance and greater agency problems. Acceleration is not costless to firms as it decreases the amount of service required of employees before enjoying the benefit from exercising (he options. Thus, we investigate whether the decision to accelerate Is driven only by financial Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R reporting motivations or by agency and economic motivations as well. Second, we investigate whether the acceleration decision represents benign changAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R
es in employees’ compensation contracts in that it does not represent wealth transfers from sliareholders to employees by examining the stock market rAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-RPreeti choudharyDoctoral StudentFuqua School of Business, Duke UniversityP.O Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-RMarch 2004 to November 2005 and a control sample of 665 firms. We observe a rapid increase in the number of accelerated vesting announcements subsequent to the passing of SPAS 123-R indicative of managerial motivation to avoid recording a stock option expense. Moreover, our results indicate that the Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R likelihood that a firm accelerates ESO vesting is increasing in the extent of financial reporting benefits. That is, firms that “save” more future stAccelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R
ock option expense are more likely to accelerate, and firms with significant underWater options are more likely to accelerate. We also find that accelGọi ngay
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