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Journal of Business Economics

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20.11.2019 | Original Paper

Expensing performance-vested executive stock options: is there underreporting under IFRS 2?

verfasst von: Alexander Merz

Erschienen in: Journal of Business Economics | Ausgabe 3/2020

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Abstract

This study generates new empirical evidence on the issue of underreporting of executive stock options. It is the first under the mandatory expense setting of International Financial Reporting Standard (IFRS) 2 and to include performance-vested options. I use a hand-collected data sample from Germany, where performance vesting has a longer history than in other countries. I find that many firms fail to disclose all required parameters and underreport the values of the options. Besides inexperience with preparing IFRS reports, incentives to hide higher pay are associated with this reporting behavior. Additionally, firms with more complex options underreport more. Since the German setting shares many institutional similarities with other (European) IFRS countries, the results are of interest to shareholders, standard setters, and enforcement authorities in such countries.

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Journal of Business Economics

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For a more comprehensive summary of insights generated from SFAS 123(r) and IFRS 2, see Merz (2017).

See, for example, Bechmann and Hjortshøj (2009) for Denmark and Melis and Carta (2010) for Italy or Bassett et al. (2007) for Australia.

In Italy, options were likewise introduced in the late 1990 and have rarely been used (Melis and Carta 2010). In France, there were only 46 ESO issues between 2005 and 2014 (Belze et al. 2015). Finally, in Denmark, only 64 of the 200 listed firms used ESO in 2005 (Bechmann and Hjortshøj 2009).

These are also referred to as premium options, and while being out of the money is technically not a vesting condition, it has the same effect. This is why I will use performance condition and exercise condition synonymously. In the robustness section, I will account for the distinction.

If options are dividend protected, dividends need not be considered for the valuation.

See La Porta et al. (1997, 1998, 2006).

More details on the reforms and their economic consequences can be found in Ernstberger et al. (2012).

These changes notwithstanding, the DPR announced in 2007 to focus more on compliance with IFRS 2, which signals that noncompliance had already been noted. However, by the end of 2011 (the end of my sample), only one firm had been cited in the national registry.

Disclosing information on the valuation was voluntary prior to IFRS 2 and only 20% of firms provided it (Bassett et al. 2007).

See Ernstberger and Vogler (2008) for more on the differences between German GAAP and IFRS.

Together the indexes account for roughly 90% of market capitalization in Germany.

Similar trends can be observed in Denmark and France (Bechmann and Hjortshøj 2009; Belze et al. 2015).

Several firms mention that they make adjustments to the Black–Scholes Model to incorporate specifics of their ESO plans, yet do not mention what those adjustments are.

Stock appreciation rights (SAR) must be revalued at the end of each fiscal year until exercised or expiration. In this case, I evaluate the underreporting at the end of the year in which they were first issued.

When options are dividend-protected, they are treated accordingly in the valuation model.

As stated by IFRS 2, only market-based performance goals are to be included in the valuation, which this approach accounts for through simulation.

There is no obvious explanation for the high standard deviation observed in 2005.

This procedure follows Bechmann and Hjortshøj (2009) and, for the second stage, Johnston (2006).

Other variables that have been shown to affect disclosure patterns (e.g., being audited by a big-4 firm) have a much more direct link with option valuation.

Dutordoir et al. (2018) and Hoi et al. (2013) make the same argument. Untabulated results show that IFRS_EXP is indeed insignificant on the second stage.

The percentage held by the largest blockholder would be a more direct measure, yet this is hardly ever available for German firms and most studies use free float instead (e.g., Andres and Theissen, 2008).

Because of this variable, I exclude firms with a one-tier board system, which leads to a loss of four observations.

While the value of the grant depends on more than the number of options, this is a standard proxy in the literature (e.g., Dechow et al. 1996; Hodder et al. 2006).

Coles et al. (2008) argue that larger boards possess more expertise which is especially beneficial to larger, more complex firms.

Note that the ME coefficients for CROSS_LISTING are greater than one. This can occur, because the marginal effects are approximated via the first derivative at the mean, which can have a slope greater than one.

All untabulated results described in this section are available upon request.

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Titel: Expensing performance-vested executive stock options: is there underreporting under IFRS 2?
verfasst von: Alexander Merz
Publikationsdatum: 20.11.2019
Verlag: Springer Berlin Heidelberg
Erschienen in: Journal of Business Economics / Ausgabe 3/2020
Print ISSN: 0044-2372
Elektronische ISSN: 1861-8928
DOI: https://doi.org/10.1007/s11573-019-00960-3

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