Firm Characteristics, Recognition Policy and Pricing of Employee Stock Option

We examine whether and how firm characteristics, including firm size and liquidity and the implementation of a new share-based compensation recognition rule affect the relation between the employee stock option (ESO) grants (as proxied by the disclosed ESO expenses) and firm value. Prior studies provide mixed results concerning how ESOs affect firm value. We argue their findings could be attributable to self-selection and a non-uniform ESO-share price relation. We use the threshold model to address our research questions after controlling for self-selection bias. We find that markets tend to positively price ESOs for firms of large size and those with low liquidity. In addition, we find that after the new rule came into effect, ESOs became positively associated with firm value. These results are congruent with the ownership and symbolic value theory, lifecycle stages hypothesis and the contention that the ESO expensing policy enhances the quality of financial statements