Towers: Stock Price Unaffected By Options Expensing

March 31, 2004 ( - The U.S. Financial Accounting Standards Board (FASB) has come out with its mandatory stock option expensing proposal, but Towers Perrin says the effect of expensing options will have no effect on a company's stock price.

Studying 335 companies that have elected to reflect option expense on their income statements, Towers Perrin tracked share prices on the day of company declarations and during the 150 trading days before and 150 trading days after.   The results from the analysis was that share performance the same, on average, as the 900 companies comprising S&P’s 500 and mid-cap 400 indexes.

“The event study confirms the view that accounting treatment of incentives does not influence stock prices,” Richard Ericson, a Towers Perrin principal and executive compensation consultant in the firm’s HR Services business, who co-authored the study with Towers Perrin consultant Michael Grund said in a news release.  “Investors take full account of the economic cost of options, whether or not such costs are reflected on the income statement.”

The latest results from the latest study parrot a similar study conducted by Towers in 2002.   The earlier report examined 103 companies, 60 days before and 60 days after the announcement of stock option expensing (See   Expensing Options Has Little Effect On Stock Price). 

Additionally, research conducted by Watson Wyatt last year found the stock markets have already factored in the effect of stock option expensing, making the effect of mandatory expensing on a company’s stock price minimal at worst.   This contention is based on the results of a study that found the median option expense at companies increased to $11.8 million in 2001 from $7.5 million in 1999, while the per employee option expense jumped to $1,032 in 2001 from $763 in 1999. Thus, in the current market, an increase in stock option expense has already been associated with lower total returns to shareholders (TRS) (See  Option Expensing Will Not Affect Stock Price ).

In conducting the latest analysis, Towers standardized stock prices for announcing companies to a uniform $10 per share closing price on the day before announcement and adjusted to reflect general market movement.   Once adjusted for general market movement, the average stock price of announcing companies does not show any significant change during the 300 trading days surrounding the declaration.  Since stock prices do not change in response, the study shows that the economic costs of using options were previously known regardless of whether book cost would be appearing among company profit and loss expenses for the first time.

“The new accounting rules provide a singular opportunity for companies to weigh the costs and benefits of options and other incentives against the ‘perceived’ value that managers place on the incentives they get,” Gary Locke, a Towers Perrin principal and leader of the firm’s executive compensation consulting practice said in the release.  “By reducing or holding steady the cost of incentives, while increasing the value that management places on them, many companies can achieve a significant ‘win-win’ situation.”