The impacts of employee stock bonus on the value relevance of earnings per share

Purpose - In Taiwan, an employee stock bonus (ESB) was accounted for as an earnings distribution rather than an expense – a remnant of the dominance of tax law over accounting standards. To enhance the usefulness of accounting information, the Securities and Futures Bureau (SFB) requires that public companies disclose imputed earnings per share (EPS) by deducting ESB from net income for the financial reporting, effective 30 January, 2003. Although the SFB‐imputed EPS considers ESB as firm expense, it ignores the resultant inflated number of shares outstanding. Therefore, it is expected that the disclosed ESB underestimates the dilutive effects of ESB and limits the intended purpose of the ESB disclosure. The purpose of this paper is to investigate how ESB dilutes EPS and how the SFB‐imputed EPS biases the price‐earnings relation. Design/methodology/approach - Theoretical analyses and empirical tests. Findings - First it was analytically illustrated that: the SFB‐imputed EPS, compared with the proposed EPS measure, underestimates the dilutive effects of ESB; the SFB‐imputed EPS downwardly biases the price‐earnings relation; and the proposed EPS preserves the relation between stock price and earnings. Controlling for firm growth and ESB issuance, empirical results were obtained that are generally consistent with the hypotheses. The SFB‐imputed EPS yields downward‐biased estimates of price earnings multiples. The downward bias is exacerbated as the dilution of ESB increases. Originality/value - The proposed measurement of diluted EPS reflects the dilutive effect of ESB, upholds the price‐earnings relationship, and offers accounting standard‐setters a useful perspective for thinking about the dilutive effects of ESB.