Financial Accounting Regulation and Executive Compensation Design

We examine the economic consequences of the recent adoption of SFAS 123(R) in the United States. Consistent with the conjectures of prior research, our results show that the removal of favorable accounting treatment for stock options post SFAS 123(R) results in a switch from stock options to restricted stock. Further analysis shows that this shift is more prominent for high-volatility firms than for low-volatility firms and for low-growth firms than for high-growth firms, a pattern consistent with the implications of the agency theory. This study extends the literature on the economic consequences of financial reporting standards by providing evidence that the leveling of accounting treatment for different forms of equity compensation causes the design of executive compensation to converge to the economically optimal form. By empirically examining the actual consequences of a heavily debated accounting standard change, this study also provides important policy implications that can be helpful in the consideration of future regulatory accounting changes in the United States as well in other accounting jurisdictions