The Effects of Financial Reporting Costs on the Use of Employee Stock Options

This study uses data on 123 firms over an 1 1 year period to examine whether the accounting for employee stock options permits them to be used as part of an income management strategy. Using a pooled cross-sectional, time-series analysis, the value of options granted is found to be negatively related to the extent the firm is below its target level of income and positively related to the firm's use of income-increasing accounting methods. I also find weak evidence of a positive relation between the firm's relative use of income-increasing accounting methods and the probability of issuing unattached stock options rather than income-decreasing securities such as stock appreciation rights or tandem securities. However, the results from both tests are sensitive to the estimation method and are not consistent over time.