Accounting for Share-Based Payments

On December 16, 2004, the Financial Accounting Standards Board published FASB Statement No. 123 (revised 2004), which significantly changes the accounting for employee stock options. Under the new standard, equity-based compensation results in a cost to the issuing enterprise and should be measured at its fair value on the grant date, based on the estimated number of awards that are expected to vest. I contend that expensing stock or option grants is not responsive to either the needs of a corporation's creditors, or to the needs of equity investors since the cost of the share-based payments is borne only by the pre-existing shareholders; the corporation itself suffers no sacrifice in assets or other resources (unless its own shares are considered an asset, which is not the case under the present Conceptual Framework and GAAP). Hence I suggest the use of three separate statements instead of the single income statement now provided. Specifically, I propose that the first statement - the "Corporation Income Statement" - not include share-based payments as an expense. Rather, a "Statement of Costs and Benefits to Pre-existing Shareholders" would show the dilution cost to the pre-existing shareholders; this dilution cost would be determined as the amounts that, if accrued during each year throughout the vesting period and until exercise, would cumulatively sum to the intrinsic value at exercise (the price of the optioned share minus the exercise price). A combined "Statement of Enterprise Income" would then show the totals of the amounts reported in the other two statements. The combined statement would reflect the net income from operations with regard to both the corporation and its pre-existing shareholders; that is, it would reflect the cost of manufacturing products or rendering services. This paper also discusses the implications of this proposal for the debate on the distinctions between liabilities and equities and for the treatment of inseparable compound securities such as convertible bonds

Demand for the Truth in Principal-Agent Relationships

Consider the following puzzle: If earnings management is harmful to shareholders, why don't they design contracts that induce managers to reveal the truth? To answer this question, we model the shareholders-manager relationship as a principal-agent game in which the agent (the manager) alone observes the economic outcome. We show that the limited liability of the agent, defined as the agent's feasible minimum payment, might explain the demand for earnings management by the principal. Specifically, when the limited-liability level is high (low), a contract that induces earnings management may be less (more) costly than a truth revealing contract. This finding offers a new explanation of the demand for earnings management

Information Transfer Effects of Senior Executives' Migrations and Subsequent Write-offs

In this study, we consider whether the market conditions its reactions to a senior executive’s (SE) move from an origin company (OC) to a destination company (DC) on the SE’s past performance and any other information impounded in the market reaction to the SE’s emigration from the OC. We also examine whether the market perceives a benefit in the hiring of an SE with an industry-specific background. We find that, with regard to migration events, the performance of the OC—accounting and stock—before the SE’s migration is positively associated with the market reaction to the immigration event only when the OC and the DC are members of the same industry. With respect to an OC’s contiguously subsequent write-off and restructuring events, we conjecture that subsequent large restructuring events signal hitherto unrecognized shortcomings of the emigrating SE, whereas non-restructuring asset write-offs are more likely to be a manifestation of neutral (with respect to inferences regarding the quality of the emigrating SE) big baths taken by the OC’s incoming SE. We hypothesize and find that, ceteris paribus, the market reaction to the DC’s stock at the time of the OC’s announcement of a post-immigration write-off or restructuring is negatively associated with the OC’s pre-emigration performance (which is predominantly positive in our sample), and possibly non-negatively associated with an asset write-off (which is not a restructuring event). We also conjecture that these effects are enhanced (become more negative) when the DC imports an SE from a competitor