Which approach to accounting for employee stock options best reflects market pricing?

Wayne R. Landsman (), Ken V. Peasnell (), Peter F. Pope () and Shu Yeh ()
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Wayne R. Landsman: University of North Carolina at Chapel Hill
Ken V. Peasnell: Lancaster University
Peter F. Pope: Lancaster University
Shu Yeh: National Taiwan University

Review of Accounting Studies, 2006, vol. 11, issue 2, No 4, 203-245

Abstract: Abstract We use a residual income valuation framework to compare equity valuation implications of four approaches to employee stock options (ESOs) accounting: APB 25 “recognize nothing”, SFAS 123 (revised) “recognize ESO expense”, FASB Exposure Draft “recognize and expense ESO asset” and “recognize ESO asset and liability”. Theoretical analysis shows only grant date recognition of an asset and liability, and subsequent marking-to-market of the liability, results in accounting numbers that capture the dilution effects of ESOs on current shareholder value. Out-of-sample equity market value prediction tests and in-sample comparisons of model explanatory power also support the “recognize ESO asset and liability” method.

Keywords: Equity valuation; Employee stock options; ESO asset and liability; ESO expense; Residual income; Mark-to-market (search for similar items in EconPapers)
JEL-codes: G14 M41 (search for similar items in EconPapers)
Date: 2006
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DOI: 10.1007/s11142-006-9008-x

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