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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