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Employee Stock Option Fair†Value Estimates: Do Managerial Discretion and Incentives Explain Accuracy?

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  • Leslie Hodder
  • William J. Mayew
  • Mary Lea McAnally
  • Connie D. Weaver

Abstract

We examine the determinants of managers' use of discretion over employee stock option (ESO) valuation†model inputs that determine ESO fair values. We also explore the consequences of such discretion. Firms exercise considerable discretion over all model inputs, and this discretion results in material differences in ESO fair†value estimates. Contrary to conventional wisdom, we find that a large proportion of firms exercise value†increasing discretion. Importantly, we find that using discretion improves predictive accuracy for about half of our sample firms. Moreover, we find that both opportunistic and informational managerial incentives together explain the accuracy of firms' ESO fair†value estimates. Partitioning on the direction of discretion improves our understanding of managerial incentives. Our analysis confirms that financial statement readers can use mandated contextual disclosures to construct powerful ex ante predictions of ex post accuracy.

Suggested Citation

  • 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.
    • Handle: RePEc:wly:coacre:v:23:y:2006:i:4:p:933-975
    DOI: 10.1506/ML46-8401-6222-4642
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    3. Denton Collins & Gary Fleischman & Stacey Kaden & Juan Manuel Sanchez, 2018. "How Powerful CFOs Camouflage and Exploit Equity-Based Incentive Compensation," Journal of Business Ethics, Springer, vol. 153(2), pages 591-613, December.
    4. Kusano, Masaki, 2020. "Does recognition versus disclosure affect risk relevance? Evidence from finance leases in Japan," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 38(C).
    5. Atif Ellahie & Xiaoxia Peng, 2021. "Management forecasts of volatility," Review of Accounting Studies, Springer, vol. 26(2), pages 620-655, June.
    6. Lamia Chourou, 2020. "Does Religiosity Matter to Value Relevance? Evidence from U.S. Banking Firms," Journal of Business Ethics, Springer, vol. 162(3), pages 675-697, March.
    7. Shaw, Kenneth W. & Whitworth, James D., 2022. "Client importance and unconditional conservatism in complex accounting estimates," Advances in accounting, Elsevier, vol. 58(C).
    8. Silviu-Virgil Chiriac, 2016. "Challenges Incurred In The Auditing Of Fair Value Measurements," Annals of Faculty of Economics, University of Oradea, Faculty of Economics, vol. 1(1), pages 812-822, July.

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