Impact of the Size of Board of Directors on Earnings Quality when Stock Options are Expensed Under SFAS123 (R)

Mr. Veronica Paz; Mr. Suneel Maheshwari; Mr. Geoffrey Tickell

doi:https://doi.org/10.51768/dbr.v16i1.161201502

Submit Manuscript Login / Register Subscribe

Home Page

Editorial Board Members

Mission, Aims & Scope

Current Issue

Impact of the Size of Board of Directors on Earnings Quality when Stock Options are Expensed Under SFAS123 (R)

Veronica Paz, Suneel Maheshwari, Geoffrey Tickell

https://doi.org/10.51768/dbr.v16i1.161201502

Published Online: January 03, 2015

Author Details ( * ) denotes Corresponding author

1. * Veronica Paz, Assistant Professor, Department of Accounting, Eberly College of Business and Information Technology, Indiana University of Pennsylvania, Indiana, United States

2. Suneel Maheshwari, Professor, Department of Accounting, Eberly College of Business and Information Technology, Indiana University of Pennsylvania, Indiana, United States

3. Geoffrey Tickell, Professor, Department of Accounting, Eberly College of Business and Information Technology, Indiana University of Pennsylvania, Indiana, United States

The paper examines the association between the number of Board of Director (BOD) members and earnings quality when stock options are expensed under SFAS 123 (R) as part of CEO compensation. The paper analyzes the effect of expensing CEO Stock options on earnings quality when the BOD size serves as a mitigating variable.

Design/Methodology/Approach: Data for the period of 2000-2009 was collected from three databases

– The ExecuComp database on CEO compensation, Corporate Governance database provides BOD

number and Compustat for firm specific data. SFAS 123 (R) became effective in 2005; therefore, this study omits the year 2005. The study uses publically traded US firms and compensation data for its CEOs.

Findings: Multiple regression results support a positive association between expensing of stock options and earnings quality when firms have a large number of BOD members. Results are consistent with expectations established by prior research that compare earnings quality and BOD governance.

Research Limitations/Implications: The study is conducted with US publically traded firms only.

Originality/Value: Our findings contribute to the body of knowledge on CEO stock options compensation and earnings quality as well as BOD size and earnings quality, by showing that earnings quality is stronger when stock options are expensed as part of CEO compensation especially for the firms that have a larger BOD.

Keywords

CEO compensation, Stock Options, Earnings Quality, SFAS 123 (R), Executive Compensation, Board of Directors, Corporate Governance.

Aboody, D., Barth, M.E., & Ron, K. (2004). SFAS no. 123 stock-based compensation expense and equity market values. The Accounting Review, 79(2), 251-275. doi: 10.2308/accr.2004.79.2.251.
Andersen, R.C., Mansi, S.A., & Reeb, D.M. (2004). Board characterisitics, accounting reporting integrity, and the cost of debt. Journal of Accounting & Economics, 37(3), 315-342. doi: 10.1016/j.jacceco.2004.01.004.
Attaway, M.C. (2000). A study of the relationship between company performance and CEO compensation. American Business Review, 18(1), 77-85. Retrieved from: Retrieved from http://proquest.umi.com.ezproxylocal.library.nova.edu/ pqdweb?did=47952627&Fmt=7&clientId=17038&RQT=309&VName=PQD.
Brown, L., & Lee, Y. (2006). The impact of SFAS 123R on changes in option-based compensation. SSRN Working Paper Series.
Brown, L.D., & Caylor, M.L. (2004). Corporate governance and firm performance. Retrieved from http:// ezproxylocal.library.nova.edu/login?url=http://search.proquest.com/docview/189920102?accountid=6579.
Butler, S., & Newman, N. (1989). Agency control mechanisms, effectiveness and decision making in an executive’s final year with a firm. Journal of Institutional and Theoretical Economics, 145, 451-464.
Comiskey, E., & Mulford, C.W. (2000). Guide to financial reporting and analysis. New York, NY: John Wiley & Sons. Core, J.E., Holthausen, R.W., & Larcker, D.F. (1999). Corporate governance, chief executive officer compensation, and firm performance. Journal of Financial Economics, 51(3), 371-406. doi: 10.1016/s0304-405x(98)00058-0.
Cyert, R.M., Kang, S.H., & Kumar, P. (2002). Corporate governance, takeovers, and top-management compensation: Theory and evidence. Management Science, 48(4), 21.
Dechow, P.M., & Dichev, I.D. (2002). The quality of accruals and earnings: The role of accrual estimation errors. The Accounting Review, 77 , 35 . Retrieved fr m http : / /proquest .umi .com . ezproxylocal . library. nova . ed pqdweb?did=1144790491&Fmt=7&clientId=17038&RQT=309&VName=PQD.
Durnev, A., & Kim, E.H. (2005). To steal or not to steal: Firm attributes, legal environment, and valuation. Journal of Finance, 60(3), 1461-1493. doi: 10.1111/j.1540-6261.2005.00767.x.
Erickson, M., Hanlon, M., & Maydew, E.L. (2006). Is there a link between executive equity incentives and accounting fraud? Journal of Accounting Research, 44(1), 113-143.
Fairfield, P.M., Whisenant, S., & Yohn, T.L. (2003). The differential persistence of accruals and cash flows for future operating income versus future profitability. Review of Accounting Studies, 8(2-3), 221-243. doi: 10.2139/ssrn.320060.
FASB. (1995). Statement of financial accounting standards no. 123 accounting for stock-based compensation. Retrieved from http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820923312&blobheader=application%2Fpdf.
FASB. (2004). Statement of financial accounting standards no. 123 (Revised) share-based payment. Retrieved from http:/ /www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175823287357& blobheader=application%2Fpdf.
Ferri, F., & Sandino, T. (2009). The impact of shareholder activism on financial reporting and compensation: The case of employee stock options expensing. The Accounting Review, 84(2), 433-466. doi: 10.2308/accr.2009.84.2.433.
Francis, J., LaFond, R., Olsson, P., & Schipper, K. (2004). Costs of equity and earnings attributes. The Accounting Review 79(4), 967-1010. doi: 10.2308/accr.2004.79.4.967.
Francis, J., LaFond, R., Olsson, P., & Schipper, K. (2005). The market pricing of accruals quality. Journal of Accounting and Economics, 39(2), 295-327. doi: 10.1016/j.jacceco.2004.06.003.
Healy, P.M. (1985). The effect of bonus schemes on accounting decisions. Journal of Accounting and Economics, 7(1-3),85-107. doi: 10.1016/0165-4101(85)90029-1.
Heltzer, W. (2010). The impact of SFAS No. 123(R) on financial statement conservatism. Advances in Accounting, 26(2), 227-260. doi: 10.1016/j.adiac.2010.04.006.
Hermalin, B.E., & Weisbach, M.S. (1991). The effects of board composition and direct incentives on firm performance. Financial Management, 20(4), 101.
Hermalin, B.E., & Weisbach, M.S. (2003). Boards of directors as an endogenously determined institution: A survey of the economic literature. Economic Policy Review - Federal Reserve Bank of New York, 9(1), 7-26. Retrieved from http:// ezproxylocal.library.nova.edu/login?url=http://search.proquest.com/docview/210395573?accountid=6579.
Huang, H., Wang, Q., & Zhang, X. (2009). The effect of CEO ownership and shareholder rights on cost of equity capital. Corporate Governance, 9(3), 255-270. doi: 10.1108/14720700910964325.
Kanagaretnam, K., Mathieu, R., & Ramanan, R. (2009). Stock option grants, current operating performance and deferral of earnings. International Journal of Management , 2 6(1 ), 2 6-3 2. Retrieved from ht tp: //pr oqu est .umi .co m. ezproxylocal.library.nova.edu/pqdweb?did=1705193201&Fmt=7&clientId=17038&RQT=309&VName=PQD.
Kumar, K.R., Ghicas, D., & Pastena, V.S. (1993). Earnings, cash flows and executive compensation: An exploratory analysis. Managerial Finance, 19(2), 55.
Laux, C., & Laux, V. (2009). Board committees, CEO compensation, and earnings management. Accounting Review, 84(3), 869-891. doi: 10.2308/accr.2009.84.3.869.
Lin, C.C., Hua, C.Y., Lee, S.H., & Lee, W.C. (2011). The policy consequence of expensing stock-based compensation. International Journal of Accounting and Information Management, 19(1), 80-93. doi: 10.1108/18347641111105944.
McIntyre, M.L., Murphy, S.A., & Mitchell, P. (2007). The top team: Examining board composition and firm performance. Corporate Governance,7(5), 547. doi: http://dx.doi.org/10.1108/14720700710827149.
McNichols, M.F. (2002). Dicussion of the quality of accruals and earnings: The role of accrual estimation errors. The Accounting Review, 77, 61.
Norusis, M. (2010). PASW statistics 18 guide to data analysis. New Jersery: Prentice Hall.
Sloan, R. G. (1996). Do stock prices fully reflect information in accruals and cash flows about future earnings? The Accounting Review, 71(3), 289-315. Retrieved from http://www.jstor.org/stable/248290.
Watts, R.L., & Zimmerman, J.L. (1978). Towards a positive theory of the determination of accounting standards. The Accounting Review, 53(1), 112-134. Retrieved from: http://www.jstor.org/stable/245729.
Xie, B., Davidson, W.N., & DaDalt, P.J. (2003). Earnings management and corporate governance: the role of the board and the audit committee. Journal of Corporate Finance, 9(3), 295-316. doi: 10.1016/s0929-1199(02)00006-8.
Yang, Q. (2006). CEO equity compensation, external monitoring and earnings quality. (Ph.D. 3252564), Hong Kong Polytechnic University (Hong Kong), Hong Kong. Retrieved from http://proquest.umi.com.ezproxylocal.library.nova.edu/ pqdweb?did=1288646171&Fmt=7&clientId=17038&RQT=309&VName=PQD.
Yermack, D. (1996). Higher market valuation of companies with a small board of directors. Journal of Financial Economics,40(2), 185-211. doi: 10.1016/0304-405x(95)00844-5.
Young, B. (2011). Employee stock option exercise behavior and firms’ claims about employee stock option expense. (Doctoral Dissertation). Retrieved from ProQuest Dissertations and Theses database. (UMI No. 3453523).