Voluntary Disclosures That Disavow Mandatory Disclosures: The Case of Stock Options
Walter G. Blacconiere
Kelley School of Business
Indiana University
James R. Frederickson
Hong Kong University of Science and Technology
Marilyn F. Johnson
Eli Broad College of Business
Michigan State University
Melissa F. Lewis
Kelley School of Business
Indiana University
Draft 0.999: April 14, 2004
Preliminary. Comments welcome. Please do not quote without permission.
The authors thank David Aboody, Frank Acito, Dave Farber, Tom Linsmeier, Luann Lynch,
Srini Rangan, Steve Rock, Jerry Salamon, Paul Simko, and participants at accounting workshops
at UCLA, University of Connecticut, University of Colorado, Michigan State University, and
University of Virginia for comments. We also thank Hyung Soon (Ross) Park and Christine
Reinoehl for research assistance. Walt Blacconiere gratefully acknowledges the financial
support of Ernst & Young, L.L.P. and the Kelley School of Business at Indiana University.
Voluntary Disclosures That Disavow Mandatory Disclosures: The Case of Stock Options
Abstract
Accounting for employee stock options has been a controversial issue. Current U.S. regulations
require firms to either recognize employee stock options as an expense on the income statement
or disclose pro forma income figures in the footnotes adjusted for this expense. Among firms
that use footnote disclosure, some firms include language that disavows the calculation of stock
option compensation. This study investigates the decision to disavow stock option compensation
expense disclosed in the footnotes. We consider two non-mutually exclusive hypotheses. First,
we predict that some firms disavow due to concerns about the reliability of the stock option
compensation amount. Second, we predict that some disavowals are motivated by executive
compensation costs. Based on a sample of over 1,300 firms during 2001, we find that over 18%
disavow pro forma income adjusted for stock option compensation. Our evidence provides only
weak support for the prediction that disavowals are related to reliability concerns. However,
there is stronger support for our predictions regarding compensation concerns. We find that
sample firms are more likely to assert that pro forma income is unreliable in cases where the
CEO’s stock option compensation is high relative to total to the CEO’s total compensation and in
cases where the CEO’s total compensation is “excessive”. These latter results suggest that
executive compensation costs influence disavowal decisions.
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
1. Introduction
The Financial Accounting Standards Board (FASB) issued SFAS 123, “Accounting for
Stock Options,” in 1995. This accounting standard requires that firms calculate the expense for
stock options granted to employees based on the fair value of the options on the grant date.
However, SFAS 123 gives firms a choice between income statement recognition versus footnote
disclosure. Specifically, a firm either can recognize stock option compensation expense as a
determinant of reported net income in the income statement (i.e., income statement recognition)
or the firm can forego income statement recognition and instead disclose pro forma income
figures in the footnotes that assume stock option compensation was expensed (i.e., footnote
disclosure). Although the exposure draft of SFAS 123 required income statement recognition
and the FASB encourages income statement recognition, the vast majority of U.S. firms
historically elected footnote disclosure.1
Among firms that use footnote disclosure, some firms include language that disavows the
calculation of the stock option compensation expense amount. For example, Intel includes the
following disavowal statement in the stock option footnote from their fiscal 2001 annual report:
The Black-Scholes option valuation model was developed for use in estimating the fair value of
traded options that have no vesting restrictions and are fully transferable. In addition, option
valuation models require the input of highly subjective assumptions, including the expected stock
price volatility. Because the company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in the opinion of management, the existing models
do not necessarily provide a reliable single measure of the fair value of employee stock options.
1
According to The Wall Street Journal Online (April 22, 2003), only five publicly-held firms (Boeing
Co., Hawaiian Electric Industries, Winn-Dixie Stores Inc., Level 3 Communications Inc., and MacDermid
Inc) treated stock option compensation as an expense in prior periods. However, many additional firms
started reporting stock option compensation expense in net income more recently. For example, Weil and
Cummin [2004] state that “nearly 500 U.S.-listed companies have begun expensing stock option pay or
intend to start” (p. C1). See Aboody, Barth, and Kasznik (2004) for an examination of the factors
associated with firms’ decisions to voluntarily recognize stock-based compensation expense under SFAS
123.
1
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
The research question addressed in the paper is: why do firms disavow the mandated
accounting disclosure concerning stock option compensation expense? More specifically, this
study investigates the decision to disavow stock option compensation expense disclosed in the
footnotes. We posit that this decision is made because the firm (or the firm’s manager) perceives
that the benefits of disavowing outweigh the costs.2 We investigate two hypotheses regarding
the decision to disavow. First, we predict that some disavowals are motivated by concerns about
the reliability of the stock option compensation amount. In effect, these firms are conveying
concerns regarding the validity of the option pricing model and/or assumptions used to compute
the compensation amount. Second, we expect that some disavowals are motivated by
compensation-related incentives. If executive compensation appears to be excessive and/or the
CEO receives a substantial portion of total compensation from stock option grants, we expect
that the firm is more likely to disavow stock option compensation reported in the footnotes.
Three characteristics of this particular setting motivate our investigation. First, the effect
of stock option compensation expense on earnings appears to be significant. Botosan and
Plumlee [2001] find that pro forma fully diluted earnings per share adjusted for stock option
compensation is at least 22% lower than the amount based on reported net income for a sample
100 of “America’s fastest-growing” firms (as identified by Fortune magazine).3 More recently,
2
For example, benefits could include the perception that the firm is enhancing the quality of the financial
statement disclosures by providing additional useful information to stakeholders (e.g., alerting
shareholders about legitimate reliability concerns in estimating stock option compensation expense).
However, firms might be hesitant to include statements that explicitly contradict information in their
audited financial statements that is required under GAAP. Such disavowals could be interpreted as the
firm having lower quality financial reporting.
3
As an extreme example, Yahoo! Inc. reported net income of over $70 million for fiscal 2000 while
disclosing stock option compensation adjusted pro forma loss in the footnotes of over $1.2 billion.
2
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
Taub [2004] notes that earnings per share for the S&P 500 would be reduced by an estimated
7.4% if stock option compensation expense is included in reported net income.
Second, stock option accounting has been and continues to be an important and
controversial issue. The FASB proposed income statement recognition for stock option
compensation in 1993, but relaxed its position and ultimately allowed either income statement
recognition or footnote disclosure in the face of significant lobbying and the threat of
Congressional action.4 On March 31, 2004, the FASB issued an Exposure Draft (titled “ShareBased Payment”) that calls for income statement recognition of estimated stock option
compensation expense. Again, the FASB’s current proposals have generated significant
controversy.5
Third, the voluntary disavowal of a mandated accounting disclosure included in audited
financial statements is relatively rare in practice. Although almost all firms provide general
caveats regarding estimates that are included in financial statements,6 a specific statement
questioning the usefulness of accounting information is much less common. The disavowal
statements examined in our study relate to a specific measure of income that must be reported in
4
For example, Botosan and Plumlee [2001] note that there were over 1,700 comment letters related to the
exposure draft of SFAS 123. Revsine et al. [2002] note that a Senate bill was introduced that would have
eliminated the FASB’s independence by requiring the Securities and Exchange Commission to approve
all new FASB standards.
5
For example, Senators Enzi and Reid have proposed a bill that would require expensing stock option
compensation on a limited basis but would allow an exemption for small businesses and start-ups firms in
a response to the FASB proposal. In a statement following a Senate hearing last week on the FASB
proposal, Enzi said that the FASB “is ill equipped to conduct economic impact studies of the accounting
standards it adopts … It was evident that FASB is not listening to small businesses and not taking their
concerns seriously.” (Wells [2003]).
6
For example, Wal-Mart’s fiscal 2001 annual report includes the following wording in their footnote:
“The preparation of consolidated financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions. These estimates and assumptions
affect the reported amounts of assets and liabilities. They also affect the disclosure of contingent assets
and liabilities at the date of the consolidated financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results may differ from these estimates.”
3
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
an audited footnote under GAAP. Thus, we believe that an investigation of the decision to
disavow stock option compensation expense disclosed in the footnotes is warranted.
We perform analysis on a sample of over 1,300 firms from the Execucomp database. Of
these firms, 248 (18.5%), representing a wide cross-section of publicly-traded firms, include a
disavowal of stock option compensation (or the resulting pro forma income) in the footnotes of
their fiscal 2001 financial statements. Our evidence provides weak support for the prediction
that disavowals are related to reliability concerns in measuring stock option compensation.
Although the standard deviation of stock price volatility is related positively to the decision to
disavow, this relation is only significant in univariate tests. However, our results suggest that
concerns regarding executive compensation do influence the decision to disavow. We find a
significant relation between disavowals and both the ratio of the CEO’s stock option
compensation to total compensation and a measure of “excessive” CEO total compensation. As
expected, we find that firms disavow in cases where the stock option compensation expense
materially affects return on assets. Finally, our results suggest that smaller firms are more likely
to disavow.
This study contributes to accounting research in at least two areas. First, this study
contributes to prior and ongoing research related to stock option accounting (examples include
Matsunaga [1995], Aboody [1996], among many others) by investigating disavowals of stock
option accounting disclosures. This study most directly extends research that examine firms’
lobbying behavior prior to the issuance of SFAS 123 (Dechow, Hutton, and Sloan [1996] and
Hill, Shelton, and Stevens [2002]), as well as studies that investigate the question of whether
firms manage stock option compensation expense under SFAS 123 (Balsam, Mozes, and
Newman [2003] and Aboody, Barth, and Kasznik [2003]).
4
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
Second, because disavowals are voluntary, we also potentially contribute to the extensive
literature concerning voluntary disclosure (see Healy and Palepu [2001] and Core [2001] for
recent reviews of this research). In particular, this study is related to recent research that has
focused on voluntary pro forma earnings disclosures (examples include Lougee and Marquardt
[2004], Frederickson and Miller [2004], among others). In these cases, the firm voluntarily
provides two sets of financial information, one based on GAAP and one based on the firm's or
industry's own definition. The presence of the latter is an implicit disavowal of the mandated
GAAP information. In contrast, our study considers an explicit disavowal of a mandatory
footnote disclosure.
To the best of our knowledge, this is the first study to examine the determinants of a
voluntary disclosure that explicitly disavows a mandated disclosure.7 Since disavowals
seemingly circumvent the intent of mandated disclosures, it is important to understand whether
disavowals are motivated by concerns about the disclosed information or for other reasons (e.g.,
opportunism).
The remainder of the paper is organized as follows. Section two discusses accounting for
stock option compensation and develops the hypotheses investigated in the paper. Section three
presents the research design including discussion of the sample, model, and variables. Section
four presents results of our empirical analysis, and section five concludes.
2. Background and Hypothesis Development
2.1 Accounting for Stock Option Compensation
Currently, the accounting for stock options is governed by Accounting Principles Board
Opinion (APB) No. 25 and Statement of Financial Accounting Standards (SFAS) No. 123. APB
7
Frederickson, Hodge, and Pratt [2004] have a concurrent study that uses an experiment to investigate the effect of
disavowals on investor judgment.
5
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
25 (issued in October 1972) defines stock option expense as the measurement date difference
between the stock price and option exercise price, multiplied by the number of options. Since
the measurement date is defined as the date at which the exercise price and number of options
are known, the measurement date of fixed option grants is the grant date. Most employee stock
option grants have a fixed exercise price that equals the stock price at the grant date, implying
that the associated expense is zero under APB 25.
The FASB reconsidered the accounting for stock-based compensation and issued the
exposure draft of SFAS 123 in 1993. The exposure draft proposed that stock option expense be
based on option fair values at the grant date, estimated using an option-pricing model. The
FASB proposal was consistent with Black and Scholes [1973] who demonstrated that the value
of an option is not solely defined by the difference between the stock price and the exercise
price.8 However, in response to political pressure, the FASB subsequently modified its proposal
to allow firms to substitute the measurement provisions in SFAS 123 with those in APB 25.
SFAS 123 (issued in October 1995) defines stock option expense as the option’s fair
value at the measurement date. Fair value is to be calculated using an option pricing model
whose inputs include the option’s exercise price, the current stock price, the expected life of the
option, expected dividend yield, expected risk-free interest rate, and, for publicly traded firms,
the expected stock price volatility.9 Once a fair value per option has been calculated, it is
8
SFAS 123 does not dictate a specific option pricing model. However, based on a search of the EDGAR
database, Hodder, Maydew, McAnally, and Weaver [2004] find that only eight firms did not use the
Black-Scholes model to estimate stock compensation expense for 2002.
9
Use of the expected life of the option, as opposed to its stated term to maturity, reflects the fact that
employees systematically exercise options early because employee stock options are nontransferable
(Huddart and Lang [1996]).
6
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
multiplied by the number of options expected to vest and the resulting amount is amortized over
the vesting period.10
If a firm elects, instead, to use APB 25 to measure stock option expense, it must provide
footnote disclosure of a variety of items, including pro forma net income. Virtually all firms
initially applied the measurement provisions of APB 25, hence disclose pro forma net income.
Other disclosures required under SFAS 123 include inputs to the option fair value calculation
(i.e., option exercise price, expected option life, dividend yield, risk-free interest rate, and stock
price volatility), estimated fair value of options granted, vesting period, and number of options
granted, forfeited, and exercised.
2.2 Saliency and the Form of Executive Stock Option Disclosures
SFAS 123 generated significant political controversy. The FASB position suggests that
stock options are an expense that can be reliably measured and, therefore, should be recognized
in determining net income. Its position is based on the argument that issuing stock options
transfers claims on the firm’s equity from existing shareholders to employees. Because the
employees provide services to the firm, the value of the transferred ownership claims represents
a cost of generating revenue.
In contrast, opponents argue that no expense should be recognized on the income
statement because the amount of the expense cannot be reliably measured. Option pricing
models are based on assumptions – such as constant volatility – that are often not descriptively
valid. Opponents also question the applicability of option price models to the valuation of
nontransferable, forfeitable employee stock options held by risk averse, undiversified executives.
10
Use of the number of options expected to vest, rather than the number granted, reflects the fact that not
all granted options vest because some employees terminate employment before the end of the vesting
period.
7
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
More recently, significant stock price declines in high technology industries and a rise in
the number of accounting restatements and related scandals have reopened the debate about the
appropriate accounting treatment of stock options. Partly in response to pressure from
shareholder activists, several bills have been introduced into Congress. For example, Senators
Levin and McCain had sponsored a bill that would disallow the tax deductibility of employee
stock options unless the options were also treated as an expense for financial reporting purposes.
Related, the International Accounting Standards Board issued International Financial Reporting
Standard (IFRS) 2, a global standard that would require the income statement recognition of
stock option compensation expense under the fair value method. Likewise, the FASB has issued
an Exposure Draft that would require expensing of stock option compensation starting in 2005.
Much of the debate about stock option accounting has implicitly focused on the argument
that shareholders will not pay sufficient attention to unrecognized stock option compensation that
is disclosed in the footnotes to the financial statements (e.g., see Greenspan [1999], Ohl [2000]
and Orr [2001], each of whom espouses this view.) Related, companies devote resources to
lobbying about disclosure versus recognition even though the terms of stock option grants can be
inferred from information in footnotes and proxy statements. This behavior reflects a belief that
investors fail to fully use information that is presented less saliently.
Research in psychology supports this belief. Psychologists have repeatedly examined
how people form predictions in settings where the variable of interest is a stochastic function of
multiple cues (e.g., Kruschke and Johansen [1999]). A consistent finding is that cue saliency
affects judgments and decisions. For example, individuals place greater weight on particular
cues when those cues are made salient than when they are not. Psychology research also has
documented that due to limited information processing abilities, the way in which information is
8
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
presented affects judgments and decisions (Payne, Bettman and Johnson [1993]).11 Consistent
with the psychology literature, experimental studies in accounting have documented that the
form in which information is presented influences investors’ trading and/or valuation judgments
in a variety of contexts.12 There also is a growing body of archival accounting evidence
consistent with saliency effects in securities prices.13 Thus, the academic literature supports the
argument that stakeholders may be influenced by the saliency of stock option disclosures.
2.3 Hypothesis 1: Stock Option Disavowal and Reliability
The recognition of an item in the financial statements (or the disclosure of the item in the
footnotes) introduces the issue of how the item should be measured (e.g., what is the appropriate
way to measure stock option compensation). Concepts Statement 5, paragraph 3, states
“Measurement involves choice of an attribute by which to quantify a recognized item and choice
of a scale of measurement (often called “unit of measure”).” Most accountants have stronglyheld views about which is the most relevant and reliable attribute to be measured and about the
circumstances needed for recognizing changes in attributes and changes in the amounts of an
attribute. Some advocate the extant model – a mixture of historical costs and fair values, while
others support fair value accounting.
11
Libby, Bloomfield, and Nelson [2001] and Maines [1995] provide detailed surveys of the experimental
literature on financial information processing.
12
Past research has examined: recognition versus disclosure of pension liabilities (Harper, Mister, and
Strawser [1987]); classification of hybrid financial instruments (Hopkins [1996]); the framing of “bad
news” earnings preannouncements (Libby and Tan [1999]); purchase versus pooling-of-interest
accounting treatment for business combinations (Hopkins, Houston, and Peters [2000]); placement of
other comprehensive income items (Hirst and Hopkins [1998]); as well as market settings (Dietrich et al.
[2001]).
13
The effects of information saliency on price have been found in the following contexts: the
reannouncement of gains from debt-equity swaps (Hand [1990]); recognized versus disclosed write-down
information in the oil and gas industry (Aboody [1996]); and time series variation in the valuation of postretirement benefits disclosed in footnotes (Amir [1993]). Additionally, many accounting anomalies may
be viewed as reflecting the tendency of investors to neglect salient information (Sloan [1996], Teoh et al.
[1998a, 1998b], Bernard and Thomas [1989], Abarbanell and Bushee [1997], and Teoh and Wong
[2002]).
9
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
Consistent with the lack of consensus in the accounting profession, Concepts Statement 5
does not advocate a particular measurement attribute. Rather, it concludes (paragraph 90) that
“information based on current prices should be recognized if it is sufficiently relevant and
reliable to justify the costs involved and more relevant than alternative information.” Further,
Concepts Statement 2, paragraph 59 states, “The reliability of a measure rests on the faithfulness
with which it represents what it purports to represent, coupled with an assurance for the user,
which comes through verification, that it has that representational quality.” Thus, information is
reliable when investors and other stakeholders can use it with confidence.
The FASB’s position that firms should recognize employee stock options as an expense
in determining net income is based on two factors: (1) such stock options represent compensation
expense and (2) firms can reliably measure the amount of this expense. The FASB’s position for
the former is based on the argument that issuing stock options to employees transfers claims on
the firm’s equity from existing shareholders to employees while its position for the latter is the
existence of option pricing models.
Opponents of recognizing stock option compensation generally argue that option pricing
models do not reliably measure the value of employee stock options for at least two reasons.
First, some assumptions underlying existing option pricing models are likely to be violated in
practice (Black [1988]). For example, not only does the Black-Scholes model assume that the
stock’s volatility is known and does not change over the option’s life, it also assumes that stock
prices change smoothly (i.e., prices do not “jump up or down” significantly over short time
periods). Further, Hodder, Maydew, McAnally, and Weaver’s [2004] results suggest that the
10
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
subjectivity of the input assumptions for the Black-Scholes model impairs the reliability of stock
option compensation expense calculated using this model.14
However, it is likely the Black-Scholes model would provide reasonable estimates of
stock option compensation expense for some firms. For example, the volatility of stock returns
could be relatively constant for a given firm. Likewise, the results of Alford and Boatsman
[1995] suggest that historical volatility is useful for predicting long-term volatility, so estimates
of expected volatility are likely to be accurate for many firms.
This discussion suggests that whether an option pricing model provides reasonable
estimates of stock option compensation depends on how well the firm matches the assumptions
underlying the option pricing model. The less descriptively valid the assumptions are for a
particular firm, the less likely the option pricing model will reliably value that firm’s options.
Because it is likely that some firms match the assumptions underlying option pricing models
reasonably well, concern about the reliability of stock option compensation is likely to be a
significant issue for only a subset of all firms. If managers’ disavowals of SFAS 123 disclosures
are motivated by concerns about the reliability of financial statement disclosures, then:
H1:
The decision to disavow is related positively to concerns about the reliability of pro
forma income adjusted for stock option compensation expense.
2.4 Hypothesis 2: Stock Option Disavowal and Executive Compensation
Regulations that mandate the public disclosure of information about executive pay
practices can impose significant costs on executives by increasing the transparency of executive
compensation contracts. The resulting costs to executives may take several forms. First, lower
14
Opponents also argue that extant option valuation models yield unreliable estimates for employee
options because they overestimate the value of non-tradable options held by undiversified, risk-averse
executives (e.g., Hall and Murphy [2002] show that undiversified executives assign a lower value to
executive stock options compared to the Black-Scholes model).
11
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
information costs lead to a reduction in shareholders’ monitoring costs and, therefore, increased
monitoring of executive pay practices. Models of reputation formation such as Diamond [1989]
demonstrate that if attempts by a manager to obtain excessive pay are sufficiently penalized,
even “bad” managers will be induced to support pay policies that maximize shareholder wealth
as a result of their desire to mimic “good” managers. However, Dyck and Zingales [2002] note
that such models assume that a manager’s type is revealed with a probability of one. In the
absence of public disclosure, such an assumption may not be descriptively valid. When
information about pay is publicly disclosed, it is more apt to be widely disseminated and a higher
proportion of shareholders are apt to be informed. Thus, it is more likely that agency costs
arising from sub-optimal pay practices will be constrained when the transparency of
compensation contracts increase.
Second, informed stakeholder groups can significantly influence compensation policies
by exerting political pressure. For example, Joskow, Rose and Wolfram [1996] provide evidence
that political pressure constrains CEO pay in the electric utility industry. Dial and Murphy
[1995] argue that General Dynamics responded to political concerns about pay practices by
modifying the terms of its performance-based compensation plans. Zenner and Perry [1997] and
Rose and Wolfram [1997] find that firms responded to the $1 million cap on the tax deductibility
of non-performance based pay by substituting performance-based compensation for fixed pay.
Third, mandatory disclosure increases the saliency of pay practices to the general public
and the coverage of executive pay by the press.15 Negative publicity concerning compensation
15
The media plays a critical role in the dissemination of information about executive compensation
(Murphy [1999], pp. 49-52). The media prefers mandatory disclosure because information that is
mandatory is less apt to be provided by the company on a quid pro quo basis and is less apt to be
selectively disclosed.
12
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
policies can lead to a substantial loss in the executive’s reputation in the eyes of society at
large.16 Although nonpecuniary, these reputational costs are likely to matter to executives.
Consistent with arguments that public disclosure of compensation information is costly to
managers, prior research suggests that executives take actions to reduce the transparency of
compensation by “managing” information related to stock options. Murphy [1996] reports
evidence consistent with executives managing proxy statement disclosures to lower the implied
value of stock options. Related, Yermack [1998], Baker [1999] and Aboody, Barth, and Kasznik
[2003] find evidence that firms manage stock option compensation expense in an attempt to
avoid political costs related to excessive compensation.
Similarly, concerns regarding executive compensation appear to influence lobbying
behavior related to the accounting for stock options. Dechow et al. [1996] presents evidence that
lobbying against the SFAS 123 Exposure Draft is related to the relative amount of stock option
compensation paid to top executives. Related, Hill et al. [2002] find that lobbying against
disclosure of stock option compensation information proposed by the FASB is related positively
to stock compensation paid to the top five executives.
In summary, increased executive compensation disclosures are costly to executives.
Such disclosures increase the likelihood that information about executive compensation policies
will be disseminated to stakeholder groups who can negatively affect compensation contracts
16
An example of the reputational effects to executives that can arise from public criticism of various
aspects of a company’s corporate governance structure is a full-page ad that ran in the April 1992 Wall
Street Journal. Paid for by shareholder activist, Robert Monks, the ad featured a photo of the Sears board
of directors and a caption, “The non-performing assets of Sears.” Embarrassed by the advertisement,
directors quickly adopted Monks’ governance reforms (including modifications to the structure of
executive compensation), despite the fact that Monks’ bid for election to the board had failed (Dyck and
Zingales [2002]).
13
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
and/or impose significant reputational penalties.17 Thus, top executives who receive substantial
compensation from stock options have incentives to reduce the transparency of stock option
grants. Benefits to reduced transparency include – but are not limited to – increased voting
support for stock option plans, reduced shareholder activism, a lower probability of regulatory
intervention, and a reduction in various non-pecuniary costs. Dechow et al. [1996] note that
while it is difficult to assess the exact magnitude of costs of this nature, it is safe to assume that
even if such costs are small to the firm, they are large relative to the size of executive
compensation. Thus, executives will attempt to reduce these costs. If disavowal of stock option
compensation expense disclosed in the footnotes is motivated by the cost to the CEO of public
scrutiny of compensation policies, then we predict that:
H2:
The decision to disavow is related positively to concerns regarding executive
compensation.
3. Research methodology
3.1 Sample
Our initial sample consists of the S&P 500, S&P 400 MidCap, and S&P 600 SmallCap
firms covered by the 2002 Execucomp data base. Of the 2,507 firms (8,699 executives) listed on
Execomp, 1,482 firms (7,674 executives) had 2001 compensation data for the firm’s CEO. We
collected stock option footnote data for 1,342 of these firms.18 The elimination of firms with
17
Hirshleifer, Lim, and Teoh [2003] develop a model in which misinterpretation of the valuation
implications of stock option disclosures arises as a result of limited shareholder attention. Salient
information is given more weight than less salient information or than information absent from the public
information set. Expensing (not expensing) options at the time they are granted results in undervaluation
(overvaluation). In contrast to the polar extremes of expensing (not expensing) options, SFAS 123
requires the amortization of the grant-date value over the vesting period. Aboody, Barth, and Kasznik
[2001] find no evidence that amortization over the vesting period results in a mismatching of expenses
with expected future benefits.
18
Firms might use other information sources to disavow pro forma income adjusted for stock option
compensation (e.g., proxy statements, press releases, etc.). Since we focus on the voluntary disavowal of
14
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
missing data on Compustat and CRSP resulted in a sample of 1,316 in our logistic regression
models. Table 1 summarizes this process.
3.2 Model and variables
We use logistic regression to investigate hypotheses concerning the decision to disavow.
The general model is as follows:
DISAVOWj = 0 + 1 Reliability proxyj + 2 Compensation proxyj + 3 ROADIFj
+ 4 SIZE j
(1)
3.2.1 Dependent variable
Based on our analysis of the stock option footnotes, we identified three issues as the basis
for a disavowal of stock option compensation expense: (a) an explicit statement questioning the
reliability of estimated stock option compensation (or the resulting pro forma income), (b) a
statement related to the appropriateness of Black-Scholes option valuation model for non-traded
options, and (c) a statement related to the subjectivity of the input assumptions used in the option
pricing model. Table 2, panel A describes the distribution of disavowals. Out of 1,342 firms in
our sample, 248 (18.5%) disavowed stock option compensation in the footnotes of their fiscal
2001 financial statements by raising at least one of the three issues. A total of 191 (14.2%) firms
had disavowals that questioned the reliability of pro forma income adjusted for stock option
compensation expense, 232 (17.3%) firms had disavowals related to the appropriateness of
Black-Scholes option valuation model, and 236 (17.6%) firms had disavowals that raised the
subjectivity issue. There are 183 (13.6%) firms that raised all three issues in their disavowals.
We used the three issues to construct three measures of the dependent variable,
DISAVOW. The first is DISRELI, which equals 1 for firms that raised the reliability issue and 0
mandatory disclosures included in audited financial statements, we limited our search to the footnotes in
annual reports. However, we do not expect that using only annual report footnotes will bias our results.
15
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
otherwise. The second measure is DISBS, which equals 1 for firms that raised the issue of
limitations of the Black-Scholes model and 0 otherwise. The final measure is DISASS, which
equals 1 for firms that raised the assumption subjectivity issue and 0 otherwise.
3.2.2 Independent variables: Reliability concerns
Our first hypothesis predicts that the decision to disavow is related negatively to the
descriptive validity of the assumptions underlying the Black-Scholes option pricing model. One
of these assumptions is that a stock’s volatility is known and that volatility does not change over
the life of the option (Black [1988]). We argue that there is more uncertainty about stock price
volatility when historical volatility is itself volatile and when expected future volatility deviates
from historical volatility.19 We use two measures to proxy for reliability concerns: SDSDRET
and VOLRATIO. Under H1, we predict that 1 will be positive for these measures.
We define SDSDRET as the standard deviation of the estimated volatility based on CRSP
monthly stock returns for the period 1997-2001.20 Specifically, we first estimate the standard
deviation of monthly returns for each individual year (i.e., volatility for the year). Next, we
compute the standard deviation of the volatility over the five years. We expect that firms with a
higher standard deviation in estimated volatility (i.e., higher “volatility in volatility”) will find it
more difficult to determine accurate estimates of stock price volatility. Thus, we predict that
these firms will have greater concerns regarding the reliability of stock option compensation
19
The Black-Scholes model also assumes that: stock price changes are smooth, short-term interest rates
are constant, there is unlimited borrowing at a single rate, there are no restrictions on short-selling, that
transactions costs are zero, investors have constant tax rates, and early exercise of the options (which
could potentially occur if the firm is, for example, acquired) is prohibited. For the purposes of our
analysis, we assume that there is no significant variation across our sample firms in the impact of these
assumptions on the reliability of Black-Scholes values.
20
This is consistent with Alford and Boatsman [1995] who use monthly returns to predict long-term
volatility since monthly returns are approximately normally distributed (consistent with the Black-Scholes
model assumptions) while daily returns are not.
16
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
expense. Panel B of table 2 reports that the mean of SDSDRET is 0.042 with a range of 0.002 to
0.389.
We define VOLRATIO as the ratio of the estimated volatility (i.e., standard deviation of
CRSP monthly returns) for the 36 month period 2000-2002 to estimated volatility of monthly
returns for the 36 month period 1997-1999. Greater volatility in the more recent period raises
reliability concerns for two reasons. First, non-constant historical volatility suggests nonconstant future volatility, which is inconsistent with the Black Scholes assumption of constant
volatility over the option life. Second, an increase in volatility makes it more difficult to
estimate future volatility. According to the descriptive statistics in Table 2, panel B, more than
half the sample faced increasing volatility in monthly stock price returns vis-à-vis prior years
(e.g., median VOLRATIO is 1.13).
3.2.3 Independent variables: Compensation concerns
Our second hypothesis predicts that the decision to disavow is more likely when the cost
to the CEO of public scrutiny of compensation policies is high. Firms that are perceived as
paying excessive stock option compensation are more likely to attract the attention of
stakeholders (including the press) who can impose costs on these executives. We use three
measures to proxy for compensation concerns: SOC%, CEOSO% and XSCOMP. We predict
that 2 is positive under H2 for each measure.
Murphy [1996] argues that managers incur significant nonpecuniary costs from high
reported levels of compensation and, therefore, have an incentive to make financial reporting
decisions that will reduce reported executive compensation expense. Consistent with Murphy’s
argument, we expect that the relative size of a CEO’s option compensation will be related
positively to the decision to disavow stock option compensation. We use two proxies for the
17
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
relative size of the option grant. First, SOC% is the ratio of stock option compensation granted
to the CEO (Execucomp item BLK_VALU) to the total compensation paid to the CEO
(Execucomp item TDC1). When stock options comprise a larger proportion of the CEO’s total
compensation package, we expect that disavowals are more likely to reduce nonpecuniary costs
related to stock option compensation. Stock options granted to CEOs represented an average of
43.5% total CEO compensation during fiscal 2001 (see table 2, panel B); however, 294 (out of
1,438 with some data) CEOs were granted no stock options during the year while four CEOs
received 100% of their compensation in stock options.
Second, CEOSO% is the ratio of stock option compensation granted to the CEO
(Execucomp item BLK_VALU) to the total stock option compensation expenses applicable to all
employees of the firm (Compustat item # 399 adjusted for taxes).21 If this ratio is high, it
suggests that the CEO is obtaining a greater proportion of the benefits of stock option grants visà-vis employees at lower levels. Table 2, panel B reports that the median CEOSO% was just
over 10% for 2001.
Our third proxy for compensation concerns is XSCOMP, a measure of excessive CEO
total compensation. Although we expect that the stock option compensation of the CEO would
be a primary consideration in the decision to disavow, all CEOs who are viewed to be “overpaid”
are likely to be concerned about public scrutiny regarding compensation. Similar to Murphy
[1996] and Aboody, Barth, and Kasznik [2003], we determine XSCOMP by first estimating the
following model of “expected” compensation using prior year (i.e., 2000) data for all firms on
Execucomp:
18
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
ln(TOTAL COMP)i = b1ln(SALES)i + b2BM i + b3GROWTH i + b4ROA i + b5RETi
+ b61-YEAR VOL i + Σn=1to23 nIndustryin + ei
(2)
TOTAL COMP is total compensation paid to the CEO in thousands of dollars
(Execucomp item TDC1).22 SALES is reported sales in millions of dollars. BM is the ratio of
the book value of equity to the market value of equity. GROWTH is sales growth compared to
the prior year. RET is the stock return (including reinvestment of dividends) for the year
(Execucomp item TRS1YR). 1-YEAR VOL is the standard deviation of monthly stock prices
from CRSP. Industry is an indicator variable equal to one (or zero) for each of the 23 industry
groups defined in the Global Industry Classification Standard (GICS) classification system
(Execucomp item SPINDEX).23
Panel B of table 2 provides descriptive statistics related to several variables used to
estimate the model for excessive CEO total compensation. Results from estimating equation (2)
using the 2000 data are presented in table 3. ln(SALES), BM, and 1-YEAR VOL are all
significant in the model. We estimate excessive CEO compensation (XSCOMP) as the
difference between the actual ln(TOTAL COMP) for firm i for 2001 and the expected value for
firm i for 2001 computed by using the parameter estimates in table 3 and firm i data for 2001 for
the independent variables. Since the mean and median of XSCOMP are positive (see table 2,
panel B), most of the CEOs in our sample received more in total compensation than expected.
21
Item # 399 is the difference between reported net income and pro forma income (net of income tax
expense). We estimate stock option compensation expense by dividing this amount by 1 – tax rate (i.e.,
35%).
22
Specifically, TDC1 is comprised of the following: Salary, Bonus, Other Annual, Total Value of
Restricted Stock Granted, Total Value of Stock Options Granted (using Black-Scholes), Long-Term
Incentive Payouts, and All Other Total.
19
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
3.2.4 Other Independent variables
We consider two additional factors that potentially influence the decision to disavow.
First, we define ROADIF% as the difference between the return on assets (ROA) based on
reported net income (Compustat Item # 18, income before extraordinary items) and ROA based
on pro forma income adjusted for stock option compensation expense (Item # 18 minus Item #
399, the difference between reported and pro forma net income). In cases where ROA would be
significantly lower due to the adjustment for stock option compensation, we expect that
managers will have greater incentives to disavow pro forma income. Thus, we predict that 3
will be positive.
Second, we include SIZE, defined as the natural logarithm of total assets. Firm size has
been used in prior research as a proxy for various theoretical constructs (e.g., political costs,
richness of the information environment, etc.), and generally size has been found to be related
positively to disclosure (see Lang and Lundholm [1993], among others). We include a measure
of size as a control variable but make no specific predictions regarding 4.
4. Empirical results
4.1 Additional descriptive statistics and univariate analysis
Table 2, panel B includes descriptive statistics for other variables in addition to those
discussed in section 3.2 above. The mean (median) size of the sample firms, based on total
assets, is approximately $13 billion ($1.6 billion) with a range of $32 million to just over $1
trillion (Citigroup). Estimated stock compensation expense ranges from a maximum of over
$3.4 billion (Microsoft) to a minimum of – $62 million where four firms report a “negative
23
GICS was developed by Standard & Poor's in collaboration with Morgan Stanley Capital International.
A company is assigned to a single GICS sub-industry based on its principal business. Although revenue
20
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
expense” and 12 firms reported zero (out of 1,419 firms with data).24 The mean decrease in
ROA caused by reporting stock option compensation expense (DIFROA%) is about 1.5%.
Given that the mean ROA based on reported net income is 1.35% for fiscal 2001, the effect of
stock compensation expense under the fair value method appears to be significant for many
firms.
Table 4, panel A presents difference in means across selected variables for firms with a
disavowal that specifically questions the reliability of estimated pro forma income (DISRELI =
1) versus those who do not (DISRELI = 0). Firms that disavow appear to be (marginally)
smaller than other firms, but the difference is not significant. Consistent with the prediction of
H1 that disavowals are related positively to reliability concerns, firms with a greater standard
deviation in the volatility of monthly returns (SDSDRET) were more likely to disavow (p =
0.001, two-tail test). Although the ratio of recent volatility over past volatility (VOLRATIO) is
higher for firms that disavow, the difference is not significant. CEOs at disavowal firms receive,
on average, 52.5% of their compensation from stock options while CEOs at other firms receive
significantly less (p < 0.001, two-tail test), consistent with H2. CEOs at disavowal firms
received more compensation, but the difference compared to other firms is insignificant.
However, based on a comparison of XSCOMP for the two samples, it appears that CEOs of
firms that disavow stock option compensation expense received more excessive total
compensation (p = .0164, two-tail test). Interestingly, the CEOs of disavowal firms received
greater excessive compensation even though the performance of their firms (based on return on
assets, sales growth, and stock returns) was worse than the non-disavowal firms in our sample.
sources are the primary factor for classification, other factors may be used for classifying firms.
24
Under SFAS 123, it is possible that pro forma income under the fair value method is greater than net
income. For example, a firm may have stock appreciation rights that result in higher expenses under the
intrinsic value method than under the fair value method. See SFAS 123 for details.
21
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
Table 4, panel B presents Pearson (Spearman) correlation coefficients. As expected, the
three measures of DISAVOW are highly correlated. Related, alternative proxies for reliability
(i.e., SDSDRET and VOLRATIO) have correlation coefficients greater that 0.25. Likewise, the
correlation among the compensation proxies are quite high (ranging from 0.36 to 0.57). All
measures of DISAVOW are correlated positively with SDSDVOL, VOLRATIO, SOC%,
CESO%, and XSCOMP, consistent with expectations.
4.2 Logistic regression results
Table 5 reports estimates of the logistical regression models. Panel A presents results
where the dependent variable is a disavowal that specifically questions the reliability of pro
forma income adjusted for stock option compensation (i.e., DISRELI). The number of
observations varies across the models due to missing data on Compustat and/or CRSP. The
overall explanatory power of the model is significant across all six models estimated (e.g.,
Likelihood Ratio Chi-square ranges from 37.97 to 48.20 and are significant at p < 0.001).
Both SDSDRET and VOLRATIO have positive but insignificant estimated coefficients.
These results do not support the prediction that firms disavow for reliability concerns as expected
under H1. However, we find evidence that executive compensation concerns influence the
decision to disavow pro forma income adjusted for stock option compensation as predicted in
H2. The ratio of CEO stock option compensation to total compensation is related positively to
the decision to disavow (p = 0.005 and 0.003, one-tail test). Further, XSCOMP is significant in
the estimated regressions (at p < 0.05, one-tail test) consistent with H2. Although the estimated
coefficient on CEOSO% is positive, it is not significant.25
25
One potential explanation for this result involves accounting procedures for stock option compensation
expense. Although the total expense is determined at grant date, it is amortized over the period that the
option may be vested. Thus, the denominator of CEOSO% includes expenses from options granted in
prior years, and the effect of current year grants will depend on option life. Conversely, the numerator
22
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
The estimated coefficients related to the effect of stock option compensation expense on
return on assets (i.e., ROADIF) are highly significant across all six models (p < 0.001, one-tail
test). 26 Thus, firms that would face a greater decrease in ROA due to the expensing of stock
options are more likely to disavow. SIZE, defined as the natural logarithm of total assets, is
negative and significant (e.g., p-values range from 0.013 to 0.089 based on a two-tail test). This
evidence suggests that smaller firms are more likely to include a disavowal related to the
reliability of stock option compensation expense.
Results in table 5, panel B, where disavowals relate to the use of the Black-Scholes
model (DISBS), are similar to the results from panel A. The Likelihood Ratio Chi-square values
are marginally higher. In addition the p-values related to the estimated coefficients for SOC%
and XSCOMP improve, providing additional evidence in support of H2. However, the
parameter estimates for VOLRATIO are negative (but not significant) and SIZE is only negative
and significant in one of the six models presented.
Likewise, results in table 5, panel C for disavowals related to assumptions to estimate
stock option compensation expense (DISASS) are consistent with the previous panels. The
results continue to provide no support for the prediction that disavowals are made for reliability
concerns but relatively strong support for the influence of compensation concerns on the decision
to disavow. ROADIF continues to be related positively to disavowals (p < 0.001, one-tail test)
but SIZE is not significant in any of the models.27
includes the value of options granted to the CEO during 2001. In some cases, the CEOSO% is greater
than one. In these cases, we truncate the ratio to equal one.
26
Due to problems in achieving convergence when estimating the logistic model, we define ROADIF = 1
if ROADIF% > 2% and ROADIF = 0 otherwise.
27
As a specification check, we re-estimate equation (1) for selected models by including 23 industry
indicator variables based on the firm’s GICS classification. Although many of the industry parameter
estimates are significant, our results are essentially equivalent to those reported in table 5.
23
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
5. Conclusions
This paper addresses the research question: why do firms voluntarily disavow the
mandated accounting disclosures concerning stock option compensation expense? We
investigate this issue in a powerful setting since the disavowal statements examined in our study:
(a) relate to a specific measure of income that must be reported in an audited footnote under
GAAP, (b) are made by a wide cross-section of publicly-traded firms, and (c) involve an
accounting issue that has attracted international attention.
Our evidence suggests that the decision to disavow the mandated footnote disclosure of
pro forma income adjusted for stock option compensation is not a random occurrence. For
example, the larger the difference between ROA based on reported net income and ROA based
on pro forma income adjusted for stock options, the more likely it is that the firm will disavow.
We find consistent evidence that when CEOs face higher costs associated with executive
compensation, disavowals are more likely. Specifically, disavowals are more likely in cases
where a significant proportion of the CEO’s compensation is from stock option grants compared
to other sources. In further support of compensation concerns, we find that CEOs who appear to
receive excess total compensation tend to disavow. Although there is some evidence disavowals
are due to reliability concerns in univariate analysis, the lack of significance in logistic
regression models suggests, at best, only weak support for this hypothesis.
The accounting for stock option compensation expense has been controversial. There
have been significant lobbying efforts by interested stakeholders regarding this issue over (at
least) the last decade. The stock option disavowal decision examined in this study can be viewed
as a form of “lobbying” and/or an attempt to “manage perceptions”. Thus, we are able to
investigate the role of disclosure incentives in a unique and important setting.
24
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
Our findings suggest that disavow decisions in this setting are, on average, more likely to
be influenced by CEO compensation concerns as opposed to legitimate concerns about the
reliability of information reported in financial statements. Thus, regulators and other
stakeholders should be aware of the influence of managerial incentives on the decision to
voluntarily disavow mandatory accounting disclosures.
25
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
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30
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
Table 1
Sample Selection
Firms listed on Execucomp for fiscal 2001 (8,699 executives)
2,507
Less: Firms with no 2001 Execucomp compensation data
1,025
Firms with 2001 Execucomp compensation data for the firm’s CEO
1,482
Less: Firms with missing stock option footnote data from EDGAR
Firms with 2001 Execucomp and footnote data
Less: Firms with other missing data from COMPUSTAT or CRSP and outliers
Maximum number of sample firms examined in logistic regressions
140
1,342
26
1,316
31
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
Table 2
Descriptive Statistics
Panel A: Distribution of disavowals (n = 1,342)
Type of disavowal
Number of firms
Firms with a disavowal that specifically questions
the reliability of estimated stock option
compensation expense (DISRELI)
Firms with a disavowal related to the use of the
Black-Scholes model (DISBS)
Firms with a disavowal related to assumptions to
estimate pro forma income (DISASS)
Firms reporting at least one type of disavowal
191
Percentage of
the sample
14.2%
232
17.3%
236
17.6%
248
18.5%
Panel B: Descriptive statistics for other variables
Mean
Standard
Deviation
1st
Quartile
Median
3rd
Quartile
Total Assets
13,034
56,786
565
1,662
6,092
32
1,051,450
SOCE
59.62
195.87
3.69
9.87
34.73
-62.58
3,480
SDSDRET
0.042
0.033
0.023
0.033
0.050
0.002
0.389
VOLRATIO
1.21
0.44
0.92
1.13
1.38
0.42
7.55
SOC%
43.50%
31.30%
14.14%
44.67%
69.97%
0.00%
100.00%
CEOSO%
17.09%
22.11%
2.28%
10.12%
22.62%
-43.21%
100.00%
TOTAL COMP
6,653
16,985
1,251
2,762
6,673
<1
369,888
XSCOMP
0.06
1.01
-0.46
0.08
0.60
-14.1
4.52
ROA
1.35%
20.29%
0.27%
3.02%
6.73%
-458.3%
57.84%
ROADIF%
1.48%
4.10%
0.13%
0.36%
1.17%
-10.37%
86.96%
BM
0.52
0.48
0.27
0.45
0.66
-6.05
6.04
SALES
5,181
13,914
477
1,312
3,935
<1
217,799
GROWTH
7.85%
36.82%
-5.80
3.47%
15.64%
-96.72%
576.97%
RET
10.1%
53.1%
-17.9%
5.2%
28.9%
-94.7%
735.9%
Variable*
Minimum Maximum
Value
Value
32
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
*Variable definitions (where source is not stated, the item was obtained from Compustat for
fiscal 2001):
Total Assets = total assets reported at the end of fiscal 2001 in millions of dollars.
SOCE = stock option compensation expense for 2001 in millions of dollars estimated as the
difference between reported net income and pro forma income adjusted for stock option
expense (Computstat item #399) divided by 1 – tax rate (35%).
SDSDRET = standard deviation of the estimated volatility (i.e., standard deviation of CRSP
monthly returns estimated annually) for the five fiscal years 1997-2001.
VOLRATIO = ratio of the estimated volatility (i.e., standard deviation of CRSP monthly returns)
for the period 2000-2002 to estimated volatility of monthly returns for the period 1997-1999.
SOC% = ratio of stock option compensation granted to the CEO (Execucomp item
BLK_VALUE) to the total compensation paid to the CEO (Execucomp item TDC1).
CEOSO% = ratio of stock option compensation granted to the CEO to the total stock option
compensation expenses applicable to all employees of the firm (i.e., SCOE).
TOTAL COMP = total compensation paid to the CEO in thousands of dollars (Execucomp item
TDC1)
XSCOMP = a measure of excess compensation paid to the CEO as the difference between ln
(TOTAL COMP) for 2001 and an expected ln (TOTAL COMP) computed from a model
estimated using all firms reporting on Execucomp in 2000.
ROA = return on assets defined as the ratio of net income for fiscal 2001 to total assets at the end
of fiscal 2001.
ROADIF% = the difference between ROA based on net income and ROA based on pro forma
income adjusted for stock option compensation expense.
BM = ratio of the book value of equity to the market value of equity.
SALES = sales reported for fiscal 2001 in millions of dollars.
GROWTH = sales growth from 2000 to 2001.
RET = stock return (including reinvestment of dividends) for fiscal 2001 (Execucomp item
TRS1YR).
33
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
Table 3
Model estimates for excessive CEO compensation regression
The model below is estimated using all firms with available data on Execucomp during fiscal
2000. Estimated excessive CEO compensation (XSCOMP) for 2001 is calculated as the
difference between the ln (TOTAL COMP) for firm i for 2001 and the expected value for firm i
using the parameter estimates (see below) and firm i data for 2001 data for the independent
variables. See table 2 for variable definitions for TOTAL COMP, SALES, BM, GROWTH,
ROA, and RET. 1-YEAR VOL is the standard deviation of monthly prices from CRSP and
Industry is an indicator variable equal to one (or zero) for each of the 23 industry groups defined
in Global Industry Classification Standard (GICS) classification system (Execucomp item
SPINDEX).
Model: ln(TOTAL COMP)i = b1ln(SALES)i + b2BM i + b3GROWTH i + b4ROA i + b5RETi
+ b61-YEAR VOL i + Σn=1to23 nIndustryin + ei
ln(SALES)
Parameter Estimate 0.4380
Standard Error
0.020
t-statistic
21.69
2
Adjusted R =
33.96%
BM
-0.0571
0.025
-2.31
GROWTH
0.000311
0.001
0.58
ROA
0.0015
0.001
1.02
RET
0.0457
0.042
1.09
1-YEAR VOL
0.0362
0.007
5.43
# of Observations = 1672
34
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
Table 4
Univariate Analysis
Panel A: Differences in means across selected variables for firms with a disavowal that
specifically questions the reliability of estimated stock compensation expense
(DISRELI = 1) versus those who do not (DISRELI = 0)
DISRELI = 1
Mean
DISRELI = 0
Mean
Difference in
Means
t-statistic
Total Assets
8,418
12,570
-4,152
-1.49
SDSDRET
0.051
0.041
0.011
3.30†††
VOLRATIO
1.253
1.201
0.052
1.12
SOC%
52.51%
43.09%
9.42%
3.81†††
CEOSO%
17.60%
17.16%
0.45%
0.25
TOTAL COMP
8,419
6,481
1,938
0.90
XSCOMP
0.223
0.038
0.184
2.40††
ROA
-3.03%
1.91%
-4.93%
-1.67†
GROWTH
6.28%
8.18%
-1.91%
-0.76
RET
-0.23%
12.07%
12.30%
-3.17†††
Variable*
*See table 2 for variable definitions.
†, ††, †††
Indicates that the reported t-statistic is significant at p < .10, .05, and .01 (based on a twotail test), respectfully.
35
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
Table 4 (Continued)
Panel B: Pearson (Spearman) Correlation Coefficients
Variable*
DISBS
DISBS
DISASS
DISRELI
SDSD
RET
SDSD
SOC
RATIO CEOSO % %
ROA
XS
COMP
TOTAL
COMP
SALES
GROWTH
RET
ASSETS
0.93
0.86
0.13
0.02
0.01
0.13
-0.01
0.09
0.03
-0.13
0.00
-0.07
-0.09
0.87
0.11
0.01
0.01
0.12
-0.01
0.08
0.03
-0.12
-0.01
-0.07
-0.08
0.11
0.03
0.01
0.11
-0.02
0.05
0.00
-0.13
0.02
-0.09
-0.10
0.26
0.01
0.19
-0.19
0.08
-0.01
-0.25
-0.07
-0.18
-0.28
-0.07
0.02
-0.23
-0.05
0.01
0.04
-0.07
-0.16
0.00
0.56
0.11
0.57
0.40
0.01
0.12
0.07
0.00
-0.02
0.57
0.61
0.08
0.04
-0.19
0.12
0.02
0.05
0.04
0.34
0.25
-0.12
0.77
0.07
0.08
-0.09
0.14
0.54
0.10
-0.11
0.56
0.04
-0.02
0.84
0.03
0.06
DISASS
0.93
DISRELI
0.86
0.87
SDSDRET
0.11
0.10
0.11
VOLRATIO
0.03
0.01
0.04
0.41
CEOSO%
0.01
0.01
0.01
0.01
-0.03
SOC%
0.13
0.12
0.11
0.17
0.03
0.36
ROA
-0.08
-0.07
-0.08
-0.17
-0.10
0.10
-0.05
XSCOMP
0.08
0.08
0.06
0.09
0.00
0.40
0.53
-0.04
TOTAL COMP
0.04
0.04
0.04
0.05
0.03
0.11
0.27
-0.02
0.43
SALES
-0.05
-0.05
-0.05
-0.12
0.06
-0.09
0.07
0.03
0.01
0.18
GROWTH
-0.03
-0.03
-0.02
-0.05
0.01
0.05
0.01
0.03
0.04
0.09
0.08
RET
-0.07
-0.07
-0.08
-0.10
-0.07
0.08
-0.14
0.17
-0.05
-0.11
-0.06
-0.02
ASSETS
-0.01
-0.01
-0.03
-0.07
-0.02
-0.08
0.04
0.00
0.03
0.15
0.56
0.03
-0.09
-0.05
Pearson correlations are reported below the diagonal elements and Spearman correlations are reported above.
*See table 2 for variable definitions.
36
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
Table 5
Logistic Regression Results
Logistic regression is estimates of the model below are presented under alternative types of
disavowals in panels A, B, and C. ROADIF is an indicator variable equal to one if ROADIF% is
greater that 2% and zero otherwise. SIZE is the natural logarithm of total assets. See table 2 for
other variable definitions. The p-values related to parameter estimates are reported in
parentheses below each estimate. Where signs are predicted, p-values are based on a one-tail
test.
Model: DISAVOWj = 0 + 1Reliability proxyj + 2Compensation proxyj + 3ROADIFj + 4SIZEj
Panel A: Results where DISAVOW is measured using DISRELI
Variable
Expected
sign
Intercept
(?)
-1.483
(0.001)
-1.562
(0.001)
-1.366
(0.002)
Reliability proxy
SDSDRET
(+)
1.900
(0.194)
2.563
(0.120)
2.563
(0.120)
VOLRATIO
(+)
Compensation proxy
SOC%
(+)
CEOSOC%
(+)
XSCOMP
(+)
ROADIF
(+)
0.672
(<0.001)
0872
(<0.001)
0.803
(<0.001)
0.716
(<0.001)
0.953
(<0.001)
0.859
(<0.001)
SIZE
(?)
-0.122
(0.028)
-0.079
(0.073)
-0.100
(0.065)
-0.135
(0.013)
-0.090
(0.089)
-0.113
(0.033)
45.37
(<0.001)
1316
187
1129
37.97
(<0.001)
1293
184
1109
41.43
(<0.001)
1316
187
1129
48.20
(<0.001)
1307
187
1120
38.07
(<0.001)
1285
184
1101
42.18
(<0.001)
1307
187
1120
Likelihood Ratio
Chi-square
# observations
# DISAVOW = 1
# DISAVOW = 0
0.724
(0.005)
-1.443
(0.002)
-1.494
(0.002)
-1.302
(0.005)
0.095
(0.286)
0.092
(0.292)
0.106
(0.264)
0.768
(0.003)
0.113
(0.382)
0.178
(0.316)
0.140
(0.045)
0.160
(0.027)
37
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
Table 5 (Continued)
Logistic Regression Results
Panel B: Results where DISAVOW is measured using DISBS
Variable
Expected
sign
Intercept
(?)
-1.965
(<0.001)
-1.800
(<0.001)
-1.558
(<0.001)
Reliability proxy
SDSDRET
(+)
1.639
(0.220)
2.362
(0.123)
1.997
(0.172)
VOLRATIO
(+)
Compensation proxy
SOC%
(+)
CEOSOC%
(+)
XSCOMP
(+)
ROADIF
(+)
0.8132
(<0.001)
1.041
(<0.001)
0.959
(<0.001)
0.870
(<0.001)
1.136
(<0.001)
1.029
(<0.001)
SIZE
(?)
-0.070
(0.082)
-0.022
(0.671)
-0.045
(0.354)
-0.081
(0.101)
-0.031
(0.518)
-0.057
(0.235)
57.21
(<0.001)
1316
228
1088
46.82
(<0.001)
1293
225
1068
51.49
(<0.001)
1316
228
1088
58.25
(<0.001)
1307
228
1079
47.17
(<0.001)
1285
225
1060
52.40
(<0.001)
1307
228
1079
Likelihood Ratio
Chi-square
# observations
# DISAVOW = 1
# DISAVOW = 0
0.817
(<0.001)
-1.551
(<0.001)
-1.623
(<0.001)
-1.390
(0.001)
-0.011
(0.527)
-0.015
(0.536)
-0.000
(0.501)
0.857
(<0.001)
0.245
(0.236)
0.306
(0.185)
0.160
(0.019)
0.177
(0.011)
38
Voluntary disclosures that disavow mandatory disclosures: The case of stock options
Table 5 (Continued)
Logistic Regression Results
Panel C: Results where DISAVOW is measured using DISASS
Variable
Expected
sign
Intercept
(?)
-1.670
(<0.001)
-1.776
(<0.001)
-1.537
(<0.001)
Reliability proxy
SDSDRET
(+)
1.409
(0.253)
2.066
(0.162)
1.707
(0.209)
VOLRATIO
(+)
Compensation proxy
SOC%
(+)
CEOSOC%
(+)
XSCOMP
(+)
ROADIF
(+)
0.785
(<0.001)
0.997
(<0.001)
0.9169
(<0.001)
0.850
(<0.001)
1.097
(<0.001)
0.992
(<0.001)
SIZE
(?)
-0.063
(0.101)
-0.017
(0.718)
-0.042
(0.388)
-0.072
(0.137)
-0.026
(0.585)
-0.052
(0.278)
51.05
(<0.001)
1316
232
1084
42.09
(<0.001)
1293
229
1064
46.74
(<0.001)
1316
232
1084
52.40
(<0.001)
1307
232
1075
42.93
(<0.001)
1285
229
1056
48.01
(<0.001)
1307
232
1075
Likelihood Ratio
Chi-square
# observations
# DISAVOW = 1
# DISAVOW = 0
0.785
(0.002)
-1.459
(<0.001)
-1.532
(<0.001)
-1.306
(0.002)
-0.085
(0.6927)
-0.092
(0.703)
-0.075
(0.671)
0.788
(0.001)
0.244
(0.235)
0.298
(0.188)
0.159
(0.019)
0.174
(0.012)
39