The Role of Accounting in the Design of CEO Equity Compensation
Mary Ellen Carter
The Wharton School, University of Pennsylvania
Luann J. Lynch
Darden Graduate School of Business Administration, University of Virginia
Irem Tuna
The Wharton School, University of Pennsylvania
Current version: March 2006
ABSTRACT
We
examine the role of accounting in firms’ equity compensation choices
for CEOs. Studying ExecuComp firms in 1995-2001, we find that financial
reporting concerns are positively associated with the use of options and
negatively associated with the use of restricted stock. We also find
that financial reporting concerns are positively associated with total
CEO compensation. These results are consistent with the previously
available favorable accounting treatment for stock options influencing
firms’ choices related to equity compensation. To corroborate our
findings, we examine changes in CEO compensation in firms that begin to
expense options in 2002 and 2003. We find that these firms reduce the
use of options and increase the use of restricted stock after they start
expensing options. We find, however, that these firms do not reduce
overall CEO compensation. Results suggest that favorable accounting
treatment for stock options led to a higher use of options and lower use
of restricted stock than would have been the case absent accounting
considerations. That we detect no decrease in total CEO compensation
upon expensing options suggests that firms find it difficult to downsize
hefty executive pay packages that may have resulted from the favorable
accounting treatment for options. The results confirm that financial
reporting costs play a role in determining CEO compensation.
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