REVISITING THE RELATIONSHIP BETWEEN OPTION EXPENSING AND STOCK RETURNS

In 2002, the Financial Accounting Standards Board allowed corporations to recognize stock options as an expense on their financial statements on a voluntary basis. Option expensing became mandatory in 2004. This investigation uses two different models to reexamine the effects of the announcement of the voluntary expensing of stock options (when expensing was not mandatory) on the abnormal stock returns for a group of firms. We find that, as expected, investors prefer firms that initiated expensing stock options to firms that did not announce they were going to expense them. However, when we compared the stock returns of the announcing firms with the Market’s expectations we found opposite results. This discrepancy suggests that announcing firms possess certain attributes that differentiate them from the firms included in the Market model. The required expensing of stock options has not eliminated their controversial nature. After investigating the different effects of expensing options, future research efforts should move towards trying to understand how these effects are transmitted to the market. If analysts are in effect ignoring stock-option expense in their earnings forecasts, as suggested by Barth, Gow and Taylor (2009), then the controversy over the reporting of stock options has only just begun.