Faculty Scholarship 1994 - Present

Financial Characteristics of Companies using the Fair values and Intrinsic Methods in Accounting for Stock-based Compensation

A lot of attention is being focused these days on the accounting choices made by public companies in U.S. primarily due to the scandals related to fraudulent reporting in the last few years. Many changes have been precipitated due to these scandals, not the least of which is the formation of a new governmental oversight body to regulate auditors under the Sarbanes-Oxley Act of 2003. One of the many reasons given for the pressures on U.S. companies to fraudulently report high earnings is the use of stock-based compensation packages to reward top executives. Since most of the companies use the older intrinsic value method to account for these stock options, as opposed to the FASB recommended fair value method, some argue that the "real" cost of the compensation package is understated in the intrinsic method, giving executives an incentive to overstate the earnings in the short-term that the options vest to maximize their own returns at the expense of the stockholders. After the accounting scandals the FASB has been under pressure to re-examine this issue and not surprising the board has recently announced that it will study this issue and release a standard. In addition some companies have voluntarily chosen in the last two years to expense the options using the fair value method. The International Accounting Standards Board (IASB) has also proposed a new standard for this area in the international reporting arena. The purpose of this paper is to examine the accounting method utilized by U.S. public companies in reporting stock-based compensation packages in their most recent annual reports. A comparative analysis will be done of the companies choosing the recommended fair value method of accounting for stock-based compensation packages versus the intrinsic value method. The results of the study will be useful for the regulators and the market place in examining the motivations of companies in using the two methods of accounting for stock-based compensation packages.