Would Stock Option Expensing Really Matter?

In a new study of the market's reaction to announcements that companies were going to expense options, Towers Perrin has found that in the 120 days surrounding the announcement by 103 companies in the summer of 2002 that they were going to expense options, stock prices at these companies did not go up or down more than would have been expected based on normalized comparative results for the market in general. "Markets are very good at reflecting available information in security prices and were already awash in information about option grants and their economic costs," said Scott Olsen, co-leader of Towers Perrin's Executive Compensation consulting practice. "The study notes that in similar past situations, stock markets have ignored accounting and have paid attention to economics when examining company accounting choices in areas like inventory, depreciation or business combinations." (Source: Announcement of Option Expensing Has No Impact on Share Price, Towers Perrin Study Finds, Nov. 21, 2003, ).

In Expensing Employee Stock Options: Lifting the Fog by Norbert Michel and Paul Garwood of the Center for Data Analysis of the Heritage Foundation (report 02-06, October 18, 2002), the authors conclude that the stock market would react with indifference to expensing stock options. The conclusion is based on a study of the market's reaction to six events from 1993 through 1995 surrounding the announcement by the FASB that it would consider requiring stock options expensing and, eventually, its announcement that it would only require expensing to appear in footnotes. The authors used a common technique in stock market research called an "event study." Event studies focus on the market's immediate reactions over one or two days to a particular announcement. The authors hypothesized that if the market "cared" about expensing, prices for companies with the highest percentage of overhang would decline relative to those with the lowest. So when announcements were made suggesting expensing would be required, the prices of companies with a lot of overhang should have gone down, and they should have gone up when the news suggested expensing might not have been required. In fact, the authors found no evidence that this happened. Instead, the market appeared indifferent to the announcements.

This conclusion, to be sure, is based on an indirect measurement , but it is intriguing that the market seems to see the additional information expensing provides (compared to what then already existed, namely the dilution form outstanding options) as at least not very compelling. It also appears to be the only empirical analysis of this issue to date. The study is available at the Heritage Foundation's Web site.