SFAS NO. 123 STOCK-BASED COMPENSATION EXPENSE AND CEO COMPENSATION

Abstract

Issuing stock options to employees and management has been a popular means of compensation used by firms for many years. For more than a decade, there has been a constant debate on whether stock-based compensation should be regarded as an expense on the financial statements. Under previous accounting rules, expensing stock options are not required and only footnote disclosures are expected. Subsequently, the release of SFAS 123 (Revised), Share Based Payment in December 2004 requires all companies to disclose stock-based compensation in income statements starting in 2006. In light of this controversy, this study seeks to provide further insights in firms’ internal views of stock options. In this study, firms from S&P 500, S&P 400 MidCap and S&P 600 SmallCap indices are selected for the investigation of the relationship between CEO compensation and stock-based expense for the years 1995-2005. A negative quadratic relationship is found for low-growth firms, suggesting that low-growth firms that use stock options extensively view them as expenses. An insignificant relationship is found for high-growth firms, indicating that these firms in general do not view stock options as an expense. There is only an exception in the results pertaining to the small-capitalization firms. They show the exact opposite relationships for both high- and low-growth firms compared to the larger firms. Lastly, results appear to be more significant for the period 1995-2005 due to heightened concern after WorldCom and Enron’s accounting scandals.