The Choice of Incentive Stock Options vs. Nonqualified Stock Options: A Marginal Tax Rate Perspective

Compensation committees seeking to minimize the joint tax liability of executives and their firms will grant tax-qualified Incentive Stock Options (ISOs) when the corporate marginal tax rate is low. Otherwise, nonqualified stock options are tax-advantageous. We test the proposition that tax motivations determine the choice between ISOs and nonqualified options by examining a sample of 364 option grants by 195 firms during the 1981 to 1984 period. Our tests employ four alternative measures of tax status, ranging from a simple dummy variable based on the firm\u27s net operating loss carryforward position to a sophisticated simulation of expected exercise year and projected marginal tax rate in that year. We find that the univariate relation between tax status and option granting behavior is insignificant for all four tax variables. However, when we control for firm size in a multivariate logistic regression, we find that one of the four variables is significant in the direction predicted by the tax hypothesis. Interestingly, it is one of the simpler measures. Our results indicate that tax considerations offer only a partial explanation for the ISO/nonqualified option choice

The influence of auditor state-level legal liability on conservative financial reporting in the property-casualty insurance industry

This paper provides the first evidence that state-level liability standards affect auditor behavior. We hypothesize that auditors demand more conservative reporting when their insurance clients are domiciled in states with more stringent standards for third-party claims against the auditor for negligence. To test this hypothesis, we analyze a sample of 3,107 loss reserve observations from 1993 through 2004. Our sample is restricted to private insurers that operate in a single state to control for auditor liability under statutory law and to reduce the possibility of forum shopping by plaintiffs. Consistent with Petroni (1992), we find that financially struggling insurers tend to under-reserve. This behavior is attenuated when the insurer is domiciled in a state that uses either the Restatement of Torts or the reasonable foreseeability standard to determine the auditor\u27s liability to third parties. Compared to the case where the auditor’s liability is defined by the legal concept of privity, these standards impose greater legal costs on auditors for ordinary negligence

The Relation Between Investor Uncertainty and Market Reactions to Earnings Announcements: Evidence from the Property-Casualty Insurance Industry in the USA

This paper investigates the relationship between investor uncertainty, gauged by properties of analysts' forecasts, and the stock market response to earnings. We find that uncertainty is best characterized by a comprehensive measure recently proposed by Barron, Kim, Lim and Stevens (1998) , BKLS. The BKLS measure is related to uncertainty-inducing events, as well as factors that affect the difficulty faced by analysts in forecasting earnings. We conclude that, first, pre-disclosure uncertainty is a significant determinant of the price reaction to the earnings release, and second, BKLS is a more comprehensive measure of uncertainty than simple dispersion. Copyright Blackwell Publishers Ltd, 2005.