Disqualifying dispositions of incentive stock options: tax benefits versus financial reporting costs

Article Abstract:

The influence of the Tax Reform Act of 1986 (TRA 86) on the desirability of incentive stock options (ISO) was analyzed in 88 disqualifying and 82 nondisqualifying firms. TRA 86 makes ISOs costlier for high-tax firms because the top corporate statutory tax rate is higher than the top individual tax rate. Moreover, the capital gains tax rate became equal to the ordinary income tax rate making the capital gains advantage of ISOs void. Disqualification of an ISO may have desirable cash flow impacts for the firm and undesirable effects on reported earnings. In the study, the firms with the highest net tax benefit tended to disqualify their exercised ISOs while firms with the highest financial reporting costs tended to exercise their ISOs. Thus, firms tend to sacrifice cash flows arising from tax savings because of the adverse impact of disqualification on reported earnings.

Economic aspects, Tax benefit rule, Incentive stock options

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Optimal exercise and the cost of granting employee stock options with a reload provision

Article Abstract:

A theoretically acceptable valuation method has been developed for determining the cost to a firm of offering reload options (REOs) to employees. A simple binomial valuation model for an unlimited American REO was represented as a function of the same observable variables that serve as the basis of standard option-pricing models. For REOs, exercising and getting a new reload grant right after the stock price exceeds any peak achieved since the REOs were granted are optimal. This optimality is not influenced by the risk aversion of the holder and any requirement to keep the stock received through early exercise. The model can be applied to firms intending to use Statement of Financial Accounting Standards No 123 to REOs.

Models, Employee benefits

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The influence of risk diversification on the early exercise of employee stock options by executive officers

Article Abstract:

The exercise of employee stock options (ESO) by executives is studied. Results show a correlation between the variance of ESO returns and the remaining life of the options at exercise. This correlation is weakened if the firm hedges the option risk. The risk of holding the option is also a joint function of the variance of the returns on the option and the extent the firm uses compensation to offset changes in the value of the executive's option portfolio.

Research, Management, Portfolio management, Executives

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