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Managerial discretion and the economic determinants of the disclosed volatility parameter for valuing ESOs

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  • Eli Bartov

    (New York University)

  • Partha Mohanram

    (Columbia University)

  • Doron Nissim

    (Columbia University)

Abstract

This study investigates the determinants of the expected stock-price volatility assumption that firms use in estimating ESO values and thus option expense. We find that, consistent with the guidance of FAS 123, firms use both historical and implied volatility in deriving the expected volatility parameter. We also find, however, that the importance of each of the two variables in explaining disclosed volatility relates inversely to their values, which results in a reduction in expected volatility and thus option value. This can be interpreted as managers opportunistically use the discretion in estimating expected volatility afforded by FAS 123. Consistent with this, we find that managerial incentives or ability to understate option value play a key role in this behavior. Since discretion in estimating expected volatility is common to both FAS 123 and 123(R), our analysis has important implications for market participants as well as regulators.

Suggested Citation

  • Eli Bartov & Partha Mohanram & Doron Nissim, 2007. "Managerial discretion and the economic determinants of the disclosed volatility parameter for valuing ESOs," Review of Accounting Studies, Springer, vol. 12(1), pages 155-179, March.
    • Handle: RePEc:spr:reaccs:v:12:y:2007:i:1:d:10.1007_s11142-006-9024-x
    DOI: 10.1007/s11142-006-9024-x
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    References listed on IDEAS

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    7. Leslie Hodder & William J. Mayew & Mary Lea McAnally & Connie D. Weaver, 2006. "Employee Stock Option Fair†Value Estimates: Do Managerial Discretion and Incentives Explain Accuracy?," Contemporary Accounting Research, John Wiley & Sons, vol. 23(4), pages 933-975, December.
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    Cited by:

    1. Mary E. Barth & Leslie D. Hodder & Stephen R. Stubben, 2013. "Financial reporting for employee stock options: liabilities or equity?," Review of Accounting Studies, Springer, vol. 18(3), pages 642-682, September.

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