IDEAS home Printed from https://ideas.repec.org/a/eee/aosoci/v52y2016icp32-49.html
   My bibliography  Save this article

The accuracy of disclosures for complex estimates: Evidence from reported stock option fair values

Author

Listed:
  • Bratten, Brian
  • Jennings, Ross
  • Schwab, Casey M.

Abstract

In this study, we exploit the unique reporting requirements for employee stock options to provide large sample evidence on the accuracy of footnote disclosures related to a specific complex estimate, the fair value of options granted. We first document the frequency and magnitude of differences between (1) the reported weighted-average fair value of options granted and (2) the calculated option fair value using the disclosed weighted-average valuation model inputs and the Black-Scholes option pricing model. In a sample of 23,358 firm-year observations between 2004 and 2011, we find that 23.9 percent have reported and calculated option fair values that differ by more than ten percent, and that these differences are sticky and are frequently significant as a percentage of net income. We also find that fair value differences are larger for firms that (1) exhibit anomalous stock option footnote disclosures that likely result from disclosure errors, (2) have more complex and hence error-prone stock option programs, and (3) have lower quality financial reporting. Taken together this evidence is consistent with large fair value differences that are primarily due to unintentional errors in the stock option footnote disclosures. To document the consequences of these fair value differences, we provide evidence that errors in the reported fair values prevent financial statement users from using the reported values to reliably estimate future stock option expense for many firms. Consistent with this result, we also find that analyst forecasts are less accurate and more disperse for firms with larger fair value differences.

Suggested Citation

  • Bratten, Brian & Jennings, Ross & Schwab, Casey M., 2016. "The accuracy of disclosures for complex estimates: Evidence from reported stock option fair values," Accounting, Organizations and Society, Elsevier, vol. 52(C), pages 32-49.
  • Handle: RePEc:eee:aosoci:v:52:y:2016:i:c:p:32-49
    DOI: 10.1016/j.aos.2015.09.001
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0361368215000847
    Download Restriction: Full text for ScienceDirect subscribers only

    File URL: https://libkey.io/10.1016/j.aos.2015.09.001?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Choudhary, Preeti, 2011. "Evidence on differences between recognition and disclosure: A comparison of inputs to estimate fair values of employee stock options," Journal of Accounting and Economics, Elsevier, vol. 51(1-2), pages 77-94, February.
    2. Bebchuk, Lucian Arye & Fried, Jesse & Walker, David I, 2002. "Managerial Power and Rent Extraction in the Design of Executive Compensation," CEPR Discussion Papers 3558, C.E.P.R. Discussion Papers.
    3. Hall, Brian J. & Murphy, Kevin J., 2002. "Stock options for undiversified executives," Journal of Accounting and Economics, Elsevier, vol. 33(1), pages 3-42, February.
    4. Brian Bratten & Ross Jennings & Casey M. Schwab, 2015. "The Effect of Using a Lattice Model to Estimate Reported Option Values," Contemporary Accounting Research, John Wiley & Sons, vol. 32(1), pages 193-222, March.
    5. Doyle, Jeffrey & Ge, Weili & McVay, Sarah, 2007. "Determinants of weaknesses in internal control over financial reporting," Journal of Accounting and Economics, Elsevier, vol. 44(1-2), pages 193-223, September.
    6. Ashbaugh-Skaife, Hollis & Collins, Daniel W. & Kinney Jr., William R., 2007. "The discovery and reporting of internal control deficiencies prior to SOX-mandated audits," Journal of Accounting and Economics, Elsevier, vol. 44(1-2), pages 166-192, September.
    7. Peecher, Mark E. & Schwartz, Rachel & Solomon, Ira, 2007. "It's all about audit quality: Perspectives on strategic-systems auditing," Accounting, Organizations and Society, Elsevier, vol. 32(4-5), pages 463-485.
    8. Choudhary, Preeti, 2011. "Evidence on differences between recognition and disclosure: A comparison of inputs to estimate fair values of employee stock options," Journal of Accounting and Economics, Elsevier, vol. 51(1), pages 77-94.
    9. Emily E. Griffith & Jacqueline S. Hammersley & Kathryn Kadous, 2015. "Audits of Complex Estimates as Verification of Management Numbers: How Institutional Pressures Shape Practice," Contemporary Accounting Research, John Wiley & Sons, vol. 32(3), pages 833-863, September.
    10. Hanlon, Michelle & Slemrod, Joel, 2009. "What does tax aggressiveness signal? Evidence from stock price reactions to news about tax shelter involvement," Journal of Public Economics, Elsevier, vol. 93(1-2), pages 126-141, February.
    11. Charles Chang & Li-jiun Chen & Cheng-der Fuh, 2013. "The Pricing of Risk and Sentiment: A Study of Executive Stock Options," Financial Management, Financial Management Association International, vol. 42(1), pages 79-99, March.
    12. Himmelberg, Charles P. & Hubbard, R. Glenn & Palia, Darius, 1999. "Understanding the determinants of managerial ownership and the link between ownership and performance," Journal of Financial Economics, Elsevier, vol. 53(3), pages 353-384, September.
    13. Ying Cao & Linda A. Myers & Thomas C. Omer, 2012. "Does Company Reputation Matter for Financial Reporting Quality? Evidence from Restatements," Contemporary Accounting Research, John Wiley & Sons, vol. 29(3), pages 956-990, September.
    14. Lucian Bebchuk & Jesse Fried, 2002. "Power, rent extraction, and executive compensation," CESifo Forum, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 3(03), pages 23-28, October.
    15. William R. Kinney & Zoe‐Vonna Palmrose & Susan Scholz, 2004. "Auditor Independence, Non‐Audit Services, and Restatements: Was the U.S. Government Right?," Journal of Accounting Research, Wiley Blackwell, vol. 42(3), pages 561-588, June.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Adrienne Rhodes & Dan Russomanno, 2021. "Executive Accountants and the Reliability of Financial Reporting," Management Science, INFORMS, vol. 67(7), pages 4475-4504, July.
    2. Mamatzakis, Emmanuel, 2022. "An international study on the impact of corruption on analysts’ forecasts," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 48(C).
    3. Bucaro, Anthony C., 2019. "Enhancing auditors' critical thinking in audits of complex estimates," Accounting, Organizations and Society, Elsevier, vol. 73(C), pages 35-49.
    4. Shaw, Kenneth W. & Whitworth, James D., 2022. "Client importance and unconditional conservatism in complex accounting estimates," Advances in accounting, Elsevier, vol. 58(C).
    5. Van Landuyt, Ben W., 2021. "Does emphasizing management bias decrease auditors’ sensitivity to measurement imprecision?," Accounting, Organizations and Society, Elsevier, vol. 88(C).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Alexander Merz, 2020. "Expensing performance-vested executive stock options: is there underreporting under IFRS 2?," Journal of Business Economics, Springer, vol. 90(3), pages 461-493, April.
    2. repec:mth:ijafr8:v:8:y:2018:i:2:p:1-25 is not listed on IDEAS
    3. Merz, Alexander, 2017. "What have we learned from SFAS 123r and IFRS 2? A review of existing evidence and future research suggestions," Journal of Accounting Literature, Elsevier, vol. 38(C), pages 14-33.
    4. Inder K. Khurana & Hoyoun Kyung, 2021. "Internal control material weakness and CEO recruitment," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 48(9-10), pages 1940-1987, October.
    5. Like Jiang & Paul André & Chrystelle Richard, 2018. "An international study of internal audit function quality," Accounting and Business Research, Taylor & Francis Journals, vol. 48(3), pages 264-298, April.
    6. Hanlon, Michelle & Rajgopal, Shivaram & Shevlin, Terry, 2003. "Are executive stock options associated with future earnings?," Journal of Accounting and Economics, Elsevier, vol. 36(1-3), pages 3-43, December.
    7. Liljeblom, Eva & Pasternack, Daniel & Rosenberg, Matts, 2011. "What determines stock option contract design?," Journal of Financial Economics, Elsevier, vol. 102(2), pages 293-316.
    8. Heitzman, Shane, 2011. "Equity grants to target CEOs during deal negotiations," Journal of Financial Economics, Elsevier, vol. 102(2), pages 251-271.
    9. Dhaliwal, Dan & Erickson, Merle & Heitzman, Shane, 2009. "Taxes and the backdating of stock option exercise dates," Journal of Accounting and Economics, Elsevier, vol. 47(1-2), pages 27-49, March.
    10. Bryan, David B., 2017. "Organized labor, audit quality, and internal control," Advances in accounting, Elsevier, vol. 36(C), pages 11-26.
    11. Jean Canil & Bruce Rosser, 2015. "Evidence on exercise pricing in CEO option grants in two countries," Annals of Finance, Springer, vol. 11(3), pages 383-410, November.
    12. Chen, Jie & Song, Wei & Goergen, Marc, 2019. "Passing the dividend baton: The impact of dividend policy on new CEOs' initial compensation," Journal of Corporate Finance, Elsevier, vol. 56(C), pages 458-481.
    13. Humphery-Jenner, M., 2011. "Internal and External Discipline Following Securities Class Actions," Discussion Paper 2011-044, Tilburg University, Center for Economic Research.
    14. Lionel Almeida, 2015. "Who are the controlling shareholders? Degree and seniority of control, and CEO pay monitoring," Working Papers hal-04141391, HAL.
    15. Bengt Holmstrom & Steven N. Kaplan, 2003. "The State Of U.S. Corporate Governance: What'S Right And What'S Wrong?," Journal of Applied Corporate Finance, Morgan Stanley, vol. 15(3), pages 8-20, March.
    16. Antonio Falato, 2006. "Paying to Make a Difference: Executive Compensation and Product Dynamics," 2006 Meeting Papers 690, Society for Economic Dynamics.
    17. Hill, Mary S. & Lopez, Thomas J. & Reitenga, Austin L., 2016. "CEO excess compensation: The impact of firm size and managerial power," Advances in accounting, Elsevier, vol. 33(C), pages 35-46.
    18. Chongwoo Choe & Gloria Tian & Xiangkang Yin, 2008. "Managerial Power, Stock-Based Compensation, And Firm Performance: Theory And Evidence," Monash Economics Working Papers 21/08, Monash University, Department of Economics.
    19. Hongfei Tang, 2014. "Are CEO stock option grants optimal? Evidence from family firms and non-family firms around the Sarbanes–Oxley Act," Review of Quantitative Finance and Accounting, Springer, vol. 42(2), pages 251-292, February.
    20. Lowry, Michelle & Murphy, Kevin J., 2007. "Executive stock options and IPO underpricing," Journal of Financial Economics, Elsevier, vol. 85(1), pages 39-65, July.
    21. Der-Fen Huang & Ming-Lei Chang, 2016. "Do auditor-provided tax services improve the relation between tax-related internal control and book-tax differences?," Asia-Pacific Journal of Accounting & Economics, Taylor & Francis Journals, vol. 23(2), pages 177-199, June.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:aosoci:v:52:y:2016:i:c:p:32-49. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/aos .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.