To Expense or not to Expense Employee Stock Options: The Market Reaction by Fayez A. Elayan Brock University Kuntara Pukthuanthong San Diego State University Richard Roll Compensation Valuation, Inc. and UCLA Authors’ Coordinates Elayan Pukthuanthong Roll Department of Accounting College of Business Administration The Anderson School at UCLA College of Business Administration San Diego State University 110 Westwood Plaza Address Brock University 5500 Campanile Drive Los Angeles, CA St. Catherines, Ontario San Diego, CA 90095-1481, USA L2S 3A1, Canada 92182-8236, USA Voice 1-905-937-8543 1-619-594-5690 1-310-825-6118 E-Mail
[email protected] [email protected] [email protected] Fifth draft: July 2004 To Expense or not to Expense Employee Stock Options: The Market Reaction Abstract During 2002 and 2003, 140 publicly traded U.S. firms announced their intention to recognize an accounting expense when stock options are granted to employees. Many similar firms elected not to expense options. We study the stock market’s reaction. There is no evidence whatsoever that expensing options reduces the stock price. To the contrary, around announcement dates, we find significant price increases for firms electing to expense options and significant price declines for industry/size/performance-matched firms that did not announce expensing at the same moment. The average relative change in market values is 3.65% during a six-day window around the announcement. The magnitude of the market’s reaction to expensing depends on agency costs, the magnitude of option expenses, and financial reporting costs. The market’s reaction does not seem to be affected by contracting costs (e.g., induced by debt covenants), growth opportunities, or potential political repercussions.