Corporate Governance

: The Harvard Law School Corporate Governance Blog

Accelerated Vesting of Stock Options in Anticipation of FAS 123-R

By Harvard Law School Program on Corporate Governance (all)

(Editor?s Note: This post comes from Mohan Venkatachalam of Duke University, Shivaram Rajgopal of the University of Washington and Preeti Choudhary of Georgetown University.)

In our forthcoming Journal of Accounting Research paper entitled ?Accelerated Vesting of Stock Options in Anticipation of FAS 123-R?, we investigate what motivates firms to alter their compensation contracts in response to an accounting standard, and whether the acceleration decision represents benign changes in employees? compensation contracts by examining the stock market reactions surrounding both the acceleration date as well as the filing date.

Our analysis is based on a sample of 354 firms that announced the accelerated vesting of options between March 2004 and November 2005 and a broad control sample of 665 firms. We observe a rapid increase in the number of accelerated vesting announcements subsequent to the FASB passing FAS 123-R, suggestive of a motivation to avoid recording a stock option expense. For the median (mean) accelerating firm, accelerated vesting increases earnings as a percentage of net income by about 4% (23%). Our regression results indicate that the likelihood that a firm accelerates vesting increases with the extent of underwater options and the level of financial reporting benefits received from acceleration. We also find evidence that acceleration is associated with agency motivations. Managerial ownership and greater option holdings by the top five executives are positively associated with accelerated vesting. We also find that firms with better external governance are less likely to accelerate vesting. In particular, we find that firms with greater blockholder ownership and pension fund ownership (proxies for better governance structures) have lower likelihood of acceleration.

We find that the average market reaction to the acceleration decision is -1% over the five-day period surrounding the announcement. In addition, there is some evidence that the accelerated vesting date could have been backdated. We find systematic negative stock returns of ?1.7% 20 days before the acceleration date (not the announcement date) and positive returns of 1.4% 20 days after the acceleration date. We also find that a large majority of acceleration decisions (233 of the 365) reported the activity to the SEC six days or more after acceleration decision, supportive of backdated vesting dates.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on November 28, 2008 (boomark / email).