The Retention Effects of Unvested Equity: Evidence from Accelerated Option Vesting

The Retention Effects of Unvested Equity: Evidence from Accelerated Option Vesting Abstract We document that firms can effectively retain executives by granting deferred equity pay. We show this by analyzing a unique regulatory change (FAS 123-R) that prompted 723 firms to suddenly eliminate stock option vesting periods. This allowed CEOs to keep 33% more options when departing the firm, and we find that voluntary CEO departure rates subsequently rose from 5% to 21%. Our identification strategy exploits FAS 123-R’s almost-random timing, which was staggered by firms’ fiscal year-ends. Firms that experienced departures suffered negative stock price reactions, and responded by increasing compensation for remaining and newly hired executives. Received June 6, 2016; editorial decision October 10, 2017 by Editor Andrew Karolyi. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online. Demand for general human capital is rising across the economy, which makes it important to understand how firms can retain highly talented managers. One key retention mechanism that contract theory proposes is to defer parts of managers’ compensation into the future, by granting equity that does not vest for several years (Edmans et al. 2012). Managers who voluntarily depart their firms typically forfeit unvested equity, which raises their cost of pursuing an outside option. Boards often grant managers large amounts of time-vesting equity based on this rationale (Ittner, Lambert, and Larcker 2003). Nevertheless, whether unvested equity actually conveys retention incentives is unclear, for several reasons. First, firms may grant unvested equity primarily to provide incentives against myopic behavior, rather than to retain talent (Gopalan et al. 2014; Edmans, Fang, and Lewellen 2017). Second, poaching firms sometimes provide upfront payments that partially compensate managers for forfeiting unvested equity (Xu and Yang 2016).1 Third, models of managerial labor markets highlight that firms’ compensation policies can affect the type of managers that self-select to work for them (Lazear 2005). This endogenous sorting makes it difficult to understand whether retention is driven by firms’ vesting policies or managers’ attributes.2 As a result of these factors, causal identification is challenging, and this may explain why existing empirical work has been unable to link unvested equity to executive turnover (Fee and Hadlock 2003). This paper presents novel evidence on the retention incentives of deferred compensation. We study how executive turnover changes following the sudden elimination of stock option vesting restrictions by means of a major regulatory change in the United States, and document three primary findings. First, voluntary CEO turnover rises significantly when the amount of options forfeited upon leaving decreases. This effect is stronger when the previously unvested options are more valuable. Second, these departures precipitate declines in firm value. Third, firms respond to turnover by raising the pay of remaining executives and newly hired CEOs, implying that departures allow firms to update their beliefs about executives’ outside options. Our findings provide insights into the dynamics of managerial labor markets, and complement the literature on the determinants of forced turnover (Huson, Parrino, and Starks 2001; Eisfeldt and Kuhnen 2013; Jenter and Kanaan 2015). We establish these results by exploiting a unique feature of the accounting regulation FAS 123-R, which required firms for the first time to expense stock options in their financial statements. FAS 123-R imposed retroactive accounting charges on unvested options that firms had granted years before the standard’s adoption in December 2004. Corporate leaders vehemently opposed the new accounting expenses, which they feared would lead to a sudden drop in earnings. Motivated by such concerns, 723 firms exploited a regulatory exemption: They accelerated executives’ previously granted, unvested options to vest immediately, thereby avoiding a 23% dropoff in net income (Choudhary, Rajgopal, and Venkatachalam 2009). At the same time, however, option acceleration shortened the time until a CEO’s options vested by 19 months on average, and increased the value of their vested option holdings by 33%. This allowed departing CEOs to keep an additional $${\$}$$0.8m worth of options, an amount equal to their annual equity pay. Our hypothesis is that this sudden, large drop in departure costs led to an increase in executive turnover. A challenge to testing this hypothesis is that firms’ decisions to accelerate option vesting are endogenous. First, some unobservable variables likely affected both option acceleration and turnover. Second, estimates could be affected by reverse causality, if some firms accelerated options to provide a “golden handshake” to outgoing executives (Yermack 2006). Such endogeneity would bias estimates obtained from comparing accelerating and non-accelerating firms. We overcome this challenge by using plausibly exogenous variation in option acceleration caused by FAS 123-R’s staggered compliance dates. Specifically, firms could avoid accounting expenses by accelerating options during the first fiscal year that ended after June 15, 2005. Thus, the acceleration deadline for firms with fiscal years ending between June and December 2005 (“late fiscal-year-end firms”) was already in calendar year 2005, whereas the deadline for firms with fiscal years ending between January and May 2006 (“early fiscal-year-end firms”) was only in calendar year 2006.3 Our 2SLS identification strategy exploits this staggered compliance schedule by instrumenting for option acceleration using an indicator for whether firms had an early or late fiscal year-end. The first-stage tests whether firms accelerated more options during the fiscal year just prior to FAS 123-R compliance. The second stage then tests whether instrumented option acceleration led to higher CEO turnover during the next fiscal year.4 The fiscal years of control firms partially overlap in calendar time with the fiscal years of treated firms, allowing us to control for some time-varying, macro-level determinants of turnover. Further, because each firm is treated in only one of the two sample years, the model accounts for time-invariant firm heterogeneity. (We find similar results when using monthly variation in FAS 123-R compliance dates.) Our analysis starts by validating our fiscal year-end instrument. We show that firms were 2.5 times more likely to accelerate option vesting in their fiscal year just prior to compliance with FAS 123-R, and usually accelerated options in the final month before the regulation took effect. Firms’ fiscal year-ends also likely satisfy the exclusion restriction for an instrumental variable, as they were set years in advance of FAS 123-R and thus should be uncorrelated with any contemporaneous changes that affect turnover. We further confirm that early and late fiscal-year-end firms had identical turnover rates, firm characteristics, and CEO pay before FAS 123-R took effect. Additionally, accelerating firms’ unvested options were mostly in the money or just slightly out of the money at the time of acceleration. Hence CEOs’ potential future payoffs from retaining these options were high, and they may have found it costly to depart their firms and forfeit the options prior to acceleration. We proceed to examine how option acceleration affected CEO turnover. Prior to FAS 123-R, turnover rates were similar across firms that accelerated in 2005 or in 2006. Turnover then rose sharply after the regulation took effect, at first only for the firms that accelerated in 2005, and one year later for firms that accelerated in 2006. Turnover rates for both sets of firms then quickly converged back to pre-FAS 123-R levels. Our 2SLS regressions confirm that these sequential jumps in turnover were due to the elimination of vesting restrictions, and not unobservable variables that may have affected acceleration decisions. A one-standard-deviation increase in the fraction of options accelerated led to a rise in the voluntary CEO turnover rate from 5% to 21.2%. Turnover rose more among CEOs who would have waited longer for options to vest in the absence of acceleration, whose unvested options were more in the money, and whose vested option holdings increased by a larger amount. We also find that turnover among a broader set of top executives rose from 8.8% to 21.3%. These estimates reflect the local average treatment effect (LATE) of option acceleration on turnover, estimated within the subset of firms that chose to accelerate due to FAS 123-R. Hence, our results say little about the effect that option acceleration would have had at firms that chose not to accelerate. The external validity of our 2SLS estimates depends on how similar accelerating firms are to non-accelerators. We find that accelerating firms performed relatively worse prior to FAS 123-R (though median stock returns and ROA were still positive). This may reflect that their CEOs’ ability was more marginal than that of non-accelerating firms’ CEOs. Accelerating firms’ boards therefore may have found turnover to be less costly or presumed that CEOs would receive few attractive outside offers and instead focused on the acceleration benefit of preserving accounting earnings. As such, our estimates are most informative about the retention incentives that unvested options convey to CEOs of firms with below-average performance. The effect could be smaller for CEOs working at the most successful firms. Because departures following option acceleration were relatively sudden, they may have reduced value by disrupting firms. We find that accelerating firms’ abnormal stock returns were $$-$$1.5% in a 3-day window around voluntary CEO departure announcements, erasing $${\$}$$29m in value on average. In contrast, non-accelerating firms’ stocks were unaffected by voluntary departures, which were likely planned further in advance. This indicates that markets perceived acceleration-induced CEO departures to be costly. The documented negative returns at accelerating firms are only slightly lower in size than those estimated for other sudden departures, such as those following sudden CEO deaths (Johnson et al. 1985; Jenter, Matveyev, and Roth 2017). Consistent with these studies, the value losses we document could partly be due to search and transition costs. Indeed, accelerating firms that experienced a departure were 58% more likely to resort to appointing an interim CEO than non-accelerating firms, and spent 106 days longer searching for a permanent replacement. We show that departures may have allowed firms to learn about executives’ outside options and the required level of retention incentives. Firms that experienced turnover following acceleration were more likely to discuss retention issues in their proxy filings following the departures. Moreover, such firms subsequently raised non-departing executives’ pay by 11% on average, and newly hired CEOs’ pay by 32%, relative to accelerating firms that experienced no turnover. We also find evidence of information spillovers to accelerating firms’ peers, which increased their own executives’ unvested equity holdings after observing option acceleration. We hand-collect data to document that executives who departed accelerating firms subsequently pursued a variety of outside opportunities. Among departing CEOs, 44% took new executive positions at other firms, 21% joined boards as non-executive directors (with 8% joining as chairmen), and 17% entered consulting or investment management. Departing CEOs were on average 56 years old, and only 11% went into retirement. Among other top executives, 57% took new executive positions, 8% accepted non-executive board positions, and 6% joined consulting firms; their average departure age was 51 years. We conclude with placebo tests showing that our results likely cannot be explained by unobserved performance shocks or other variables that may differ across fiscal year-ends. First, option acceleration is unrelated to executive turnover in fiscal years prior to FAS 123-R. Second, acceleration did not affect the turnover of outside directors, who were largely unaffected by FAS 123-R because they held few unvested options (Yermack 2004). Thus, an omitted variable can confound our results only if it causes turnover among executives but not directors, and further affects late fiscal-year-end firms only in 2005 and early fiscal-year-end firms only in 2006. Finally, we show that our results are not explained by firms reporting lower net income or experiencing analyst downgrades after FAS 123-R took effect. Our paper contributes to the understanding of managerial labor markets by quantifying the effect of deferred compensation on turnover. We relate to the literature that studies determinants of forced CEO turnover, such as governance (Weisbach 1988; Denis, Denis, and Sarin 1997; Huson, Parrino, and Starks 2001; Denis and Serrano 1996), industry shocks (Jenter and Kanaan 2015; Eisfeldt and Kuhnen 2013; Peters and Wagner 2014; Kaplan and Minton 2012), or earnings management (Hazarika, Karpoff, and Nahata 2012). Our paper is most closely related to Gopalan, Huang, and Maharjan (2016), who examine turnover after annual equity grants vest. Our setting differs as we examine a large, one-time elimination of vesting periods, and study changes to pay and firm value following turnover.5 Our paper also documents new evidence on the pay consequences of CEO departures. Existing work finds that firm size determines executive pay in equilibrium, as the most productive managers sort to the largest firms (Gabaix and Landier 2008; Edmans, Gabaix, and Landier 2009). However, little is known about the dynamics that lead to this equilibrium. Our result that firms increase pay following voluntary turnover highlights one mechanism by which pay converges to its market value. Our findings also suggest that deferred pay may be a (designed) friction to managerial sorting. More broadly, we contribute to the literature on how vesting restrictions affect incentives. Cai and Vijh (2007) find that executives pursue mergers to accelerate the vesting of their equity holdings. Other papers show that CEOs with short vesting periods act myopically (Edmans, Fang, and Lewellen 2017; Ladika and Sautner 2018) and that CEOs release more news when equity vests (Edmans et al. 2017). 1. Background on FAS 123-R Prior to FAS 123-R, accounting regulations did not require firms to expense at-the-money options in their financial statements, and almost all firms avoided charges by granting executives such options.6 FAS 123-R’s main reform was to require firms to expense the fair value of all new options awards. (Since 2009, FAS 123-R has been codified as ASC Topic 718.) Additionally, firms had to expense previously granted options that had not yet vested when the regulation took effect. This provision received little attention while FAS 123-R was debated, but it created substantial, unexpected charges for firms with many outstanding unvested options. However, an exemption allowed firms to avoid these expenses by accelerating options to fully vest prior to FAS 123-R’s compliance date, which was each firm’s first full fiscal year that started after June 15, 2005 (I.A. Figure 1). Most often firms accelerated option vesting right in the month before compliance (I.A. Figure 2). Firms that accelerated unvested out-of-the-money options avoided all expenses. Firms that accelerated unvested in-the-money options had to expense the options’ intrinsic values (the difference between the acceleration-date stock price and option strike price), but for many firms this was significantly lower than the fair-value expense required in the absence of acceleration (Balsam, Reitenga, and Yin 2008). Figure 1 View largeDownload slide Hypothesis testing using staggered FAS 123-R compliance dates Panel A shows the treatment and control groups for testing the effect of FAS 123-R compliance on option acceleration (first stage), and panel B shows these groups for testing the effect of option acceleration on CEO turnover (second stage). Figure 1 View largeDownload slide Hypothesis testing using staggered FAS 123-R compliance dates Panel A shows the treatment and control groups for testing the effect of FAS 123-R compliance on option acceleration (first stage), and panel B shows these groups for testing the effect of option acceleration on CEO turnover (second stage). Figure 2 View largeDownload slide Effect of staggered FAS 123-R compliance on option acceleration The sample contains all firm-fiscal year observations ending between January 2005 and December 2006. Bars represent the percentage of firms with a fiscal year ending in a given month that accelerated option vesting during that fiscal year. The figure illustrates, for example, that 19% of firms with fiscal year ending in June 2005 accelerated option vesting during the fiscal year between July 2004 and June 2005. FAS 123-R compliance took effect for each firm in its first fiscal year starting after June 15, 2005. Firms had to accelerate option vesting before this compliance date to avoid expenses. Figure 2 View largeDownload slide Effect of staggered FAS 123-R compliance on option acceleration The sample contains all firm-fiscal year observations ending between January 2005 and December 2006. Bars represent the percentage of firms with a fiscal year ending in a given month that accelerated option vesting during that fiscal year. The figure illustrates, for example, that 19% of firms with fiscal year ending in June 2005 accelerated option vesting during the fiscal year between July 2004 and June 2005. FAS 123-R compliance took effect for each firm in its first fiscal year starting after June 15, 2005. Firms had to accelerate option vesting before this compliance date to avoid expenses. Numerous firms argued that the charges to operating earnings under FAS 123-R would reduce financial statement informativeness and lead to costly missed earnings forecasts. We find that 85% of firms that accelerated options stated in 8-K filings that the primary reason was to reduce expenses (I.A. Figure 3). Below we show that accelerating firms discussed turnover risk in financial disclosures, but only in the years after option acceleration (I.A. Table 7). Figure 3 View largeDownload slide Unvested option moneyness at accelerating firms Panel A plots the Kernel density of Unvested option moneyness, separately for accelerating and non-accelerating firms. Unvested option moneyness is the weighted average of moneyness of unvested options, measured at the end of the fiscal year just prior to FAS 123-R compliance. The variable includes all accelerated options that were scheduled to remain unvested prior to acceleration. In panel B, bars represent the fraction of accelerating or non-accelerating firms with a given percentage of deep out-of-the-money unvested options. Deep out-of-the-money options have a stock-price-to-strike-price ratio below 0.7. The ratio is measured at the end of the fiscal year just prior to FAS 123-R compliance. Figure 3 View largeDownload slide Unvested option moneyness at accelerating firms Panel A plots the Kernel density of Unvested option moneyness, separately for accelerating and non-accelerating firms. Unvested option moneyness is the weighted average of moneyness of unvested options, measured at the end of the fiscal year just prior to FAS 123-R compliance. The variable includes all accelerated options that were scheduled to remain unvested prior to acceleration. In panel B, bars represent the fraction of accelerating or non-accelerating firms with a given percentage of deep out-of-the-money unvested options. Deep out-of-the-money options have a stock-price-to-strike-price ratio below 0.7. The ratio is measured at the end of the fiscal year just prior to FAS 123-R compliance. Table 7 Comparison of accelerating versus non-accelerating firms    Accelerating firms (2001-2004)  Non-accelerating firms (2001–2004)  Difference in means     Mean  Median  SD  Obs.  Mean  Median  SD  Obs.  t-stat  CEO turnover  0.05        2,044  0.06        8,595  –2.22**  Voluntary CEO turnover  0.04        2,044  0.05        8,595  –1.91*  Voluntary CEO turnover (JKPW)  0.05        933  0.08        3,986  –2.44**  Executive turnover  0.09  0.00  0.18  1,932  0.09  0.00  0.17  8,076  –0.33  Log assets  5.68  5.64  1.75  2,028  5.92  5.95  2.03  8,467  –2.14**  Market/book ratio  2.24  1.60  1.96  1,984  2.10  1.47  2.31  8,230  1.07  Stock return  –0.01  0.05  0.58  1,946  0.07  0.13  0.52  8,028  –1.77*  Stock volatility  0.22  0.20  0.12  1,866  0.18  0.16  0.10  7,629  4.50***  ROA  –0.04  0.03  0.24  1,904  $$-$$0.02  0.05  0.22  8,103  –1.69*  Sales growth  0.14  0.08  0.32  2,003  0.13  0.08  0.31  8,311  2.04**  CEO age above 61  0.15        1,836  0.17        7,574  –1.15  Frac. executives above 61  0.08  0.00  0.20  1,927  0.10  0.00  0.23  8,032  –2.24**  Unvested option duration  21.08  19.81  11.04  1,064  20.24  18.96  11.43  4,220  2.00**  Unvested option moneyness  1.34  1.11  0.96  1,181  1.40  1.16  0.99  4,560  –1.18  Vested option value  5,774  1,934  9,461  841  7,084  1,736  11,926  3,770  –1.97*  Vested option PPS  113  47  165  841  142  48  214  3,770  –2.47**  Total compensation  3,743  2,112  4,130  959  4,129  2,407  4,342  4,328  –1.00  Equity compensation  2,356  1,081  3,171  959  2,339  976  3,249  4,328  0.05     Accelerating firms (2001-2004)  Non-accelerating firms (2001–2004)  Difference in means     Mean  Median  SD  Obs.  Mean  Median  SD  Obs.  t-stat  CEO turnover  0.05        2,044  0.06        8,595  –2.22**  Voluntary CEO turnover  0.04        2,044  0.05        8,595  –1.91*  Voluntary CEO turnover (JKPW)  0.05        933  0.08        3,986  –2.44**  Executive turnover  0.09  0.00  0.18  1,932  0.09  0.00  0.17  8,076  –0.33  Log assets  5.68  5.64  1.75  2,028  5.92  5.95  2.03  8,467  –2.14**  Market/book ratio  2.24  1.60  1.96  1,984  2.10  1.47  2.31  8,230  1.07  Stock return  –0.01  0.05  0.58  1,946  0.07  0.13  0.52  8,028  –1.77*  Stock volatility  0.22  0.20  0.12  1,866  0.18  0.16  0.10  7,629  4.50***  ROA  –0.04  0.03  0.24  1,904  $$-$$0.02  0.05  0.22  8,103  –1.69*  Sales growth  0.14  0.08  0.32  2,003  0.13  0.08  0.31  8,311  2.04**  CEO age above 61  0.15        1,836  0.17        7,574  –1.15  Frac. executives above 61  0.08  0.00  0.20  1,927  0.10  0.00  0.23  8,032  –2.24**  Unvested option duration  21.08  19.81  11.04  1,064  20.24  18.96  11.43  4,220  2.00**  Unvested option moneyness  1.34  1.11  0.96  1,181  1.40  1.16  0.99  4,560  –1.18  Vested option value  5,774  1,934  9,461  841  7,084  1,736  11,926  3,770  –1.97*  Vested option PPS  113  47  165  841  142  48  214  3,770  –2.47**  Total compensation  3,743  2,112  4,130  959  4,129  2,407  4,342  4,328  –1.00  Equity compensation  2,356  1,081  3,171  959  2,339  976  3,249  4,328  0.05  Statistics are reported for firm-fiscal year observations ending between January 2001 and December 2004, and all variables are measured at the firm-fiscal-year level. The table compares accelerating and non-accelerating firms. Statistics are reported for only those accelerating firms that accelerated options in the fiscal year before FAS 123-R took effect. t-statistics are based on standard errors that are clustered by fiscal year and Fama-French 48 industry. ***, **, and * indicate significance levels of 1%, 5%, and 10%, respectively. Some variables are available only for ExecuComp firms. The variable appendix provides the variable definitions. Table 7 Comparison of accelerating versus non-accelerating firms    Accelerating firms (2001-2004)  Non-accelerating firms (2001–2004)  Difference in means     Mean  Median  SD  Obs.  Mean  Median  SD  Obs.  t-stat  CEO turnover  0.05        2,044  0.06        8,595  –2.22**  Voluntary CEO turnover  0.04        2,044  0.05        8,595  –1.91*  Voluntary CEO turnover (JKPW)  0.05        933  0.08        3,986  –2.44**  Executive turnover  0.09  0.00  0.18  1,932  0.09  0.00  0.17  8,076  –0.33  Log assets  5.68  5.64  1.75  2,028  5.92  5.95  2.03  8,467  –2.14**  Market/book ratio  2.24  1.60  1.96  1,984  2.10  1.47  2.31  8,230  1.07  Stock return  –0.01  0.05  0.58  1,946  0.07  0.13  0.52  8,028  –1.77*  Stock volatility  0.22  0.20  0.12  1,866  0.18  0.16  0.10  7,629  4.50***  ROA  –0.04  0.03  0.24  1,904  $$-$$0.02  0.05  0.22  8,103  –1.69*  Sales growth  0.14  0.08  0.32  2,003  0.13  0.08  0.31  8,311  2.04**  CEO age above 61  0.15        1,836  0.17        7,574  –1.15  Frac. executives above 61  0.08  0.00  0.20  1,927  0.10  0.00  0.23  8,032  –2.24**  Unvested option duration  21.08  19.81  11.04  1,064  20.24  18.96  11.43  4,220  2.00**  Unvested option moneyness  1.34  1.11  0.96  1,181  1.40  1.16  0.99  4,560  –1.18  Vested option value  5,774  1,934  9,461  841  7,084  1,736  11,926  3,770  –1.97*  Vested option PPS  113  47  165  841  142  48  214  3,770  –2.47**  Total compensation  3,743  2,112  4,130  959  4,129  2,407  4,342  4,328  –1.00  Equity compensation  2,356  1,081  3,171  959  2,339  976  3,249  4,328  0.05     Accelerating firms (2001-2004)  Non-accelerating firms (2001–2004)  Difference in means     Mean  Median  SD  Obs.  Mean  Median  SD  Obs.  t-stat  CEO turnover  0.05        2,044  0.06        8,595  –2.22**  Voluntary CEO turnover  0.04        2,044  0.05        8,595  –1.91*  Voluntary CEO turnover (JKPW)  0.05        933  0.08        3,986  –2.44**  Executive turnover  0.09  0.00  0.18  1,932  0.09  0.00  0.17  8,076  –0.33  Log assets  5.68  5.64  1.75  2,028  5.92  5.95  2.03  8,467  –2.14**  Market/book ratio  2.24  1.60  1.96  1,984  2.10  1.47  2.31  8,230  1.07  Stock return  –0.01  0.05  0.58  1,946  0.07  0.13  0.52  8,028  –1.77*  Stock volatility  0.22  0.20  0.12  1,866  0.18  0.16  0.10  7,629  4.50***  ROA  –0.04  0.03  0.24  1,904  $$-$$0.02  0.05  0.22  8,103  –1.69*  Sales growth  0.14  0.08  0.32  2,003  0.13  0.08  0.31  8,311  2.04**  CEO age above 61  0.15        1,836  0.17        7,574  –1.15  Frac. executives above 61  0.08  0.00  0.20  1,927  0.10  0.00  0.23  8,032  –2.24**  Unvested option duration  21.08  19.81  11.04  1,064  20.24  18.96  11.43  4,220  2.00**  Unvested option moneyness  1.34  1.11  0.96  1,181  1.40  1.16  0.99  4,560  –1.18  Vested option value  5,774  1,934  9,461  841  7,084  1,736  11,926  3,770  –1.97*  Vested option PPS  113  47  165  841  142  48  214  3,770  –2.47**  Total compensation  3,743  2,112  4,130  959  4,129  2,407  4,342  4,328  –1.00  Equity compensation  2,356  1,081  3,171  959  2,339  976  3,249  4,328  0.05  Statistics are reported for firm-fiscal year observations ending between January 2001 and December 2004, and all variables are measured at the firm-fiscal-year level. The table compares accelerating and non-accelerating firms. Statistics are reported for only those accelerating firms that accelerated options in the fiscal year before FAS 123-R took effect. t-statistics are based on standard errors that are clustered by fiscal year and Fama-French 48 industry. ***, **, and * indicate significance levels of 1%, 5%, and 10%, respectively. Some variables are available only for ExecuComp firms. The variable appendix provides the variable definitions. FAS 123-R culminated a long, heated debate about the accounting treatment of stock options. Previous proposals to institute fair-value expensing drew substantial criticism from firms and investors, and were abandoned or watered down. Yet the corporate scandals of the early 2000s created momentum for option expensing, and opposition to FAS 123-R was relatively muted between its initial proposal in March 2004 and final adoption in December 2004. Nevertheless, firms were unable to anticipate the impact of FAS 123-R for two reasons. First, the regulation’s final compliance schedule was unexpectedly changed just two months before the regulation took effect. FAS 123-R originally required all firms to begin expensing options on June 15, 2005 (independent of their fiscal years). However, without prior notice, on April 14, 2005, the SEC delayed compliance to the first fiscal year starting after June 15, 2005. The change occurred because regulators were overburdened, and because accountants pointed out the difficulty of firms changing accounting standards in the middle of a fiscal year (McConnell et al. 2005). Second, firms initially did not know whether option acceleration would trigger accounting charges. On October 6, 2004, the Financial Accounting Standard Board (FASB) decided in a narrow 4-3 vote to permit acceleration. Almost no firm accelerated option vesting prior to the vote, due to uncertainty over its outcome (Choudhary, Rajgopal, and Venkatachalam 2009). 2. Sample, Identification Strategy, and Empirical Measures 2.1 Sample Our sampling procedure starts with all 4,991 firms that are in either the ExecuComp (mostly S&P 1500 firms) or BoardEx databases. We exclude 403 firms that voluntarily expensed stock options at fair value before FAS 123-R was proposed, because these firms could not benefit from option acceleration and also may have differed from other firms along dimensions that affect turnover (Aboody, Barth, and Kasznik 2004). We also exclude 70 firms that changed their fiscal year between 2004 and 2006, perhaps to delay compliance with FAS 123-R, and 33 firms with assets below $${\$}$$5m. Our final sample contains 4,485 firms, of which 1,704 are in ExecuComp and 2,781 are only in BoardEx. 2.2 Identification strategy 2.2.1 2SLS model Executives typically forfeit unvested options when voluntarily departing the firm. This creates a departure cost whenever an executive anticipates that she could earn positive payoffs by staying at the firm and exercising the options in the future, after they vest. We therefore predict that the likelihood of voluntary turnover is higher when more of an executive’s options have vested. A reasonable setting for testing this hypothesis is option acceleration in anticipation of FAS 123-R, because the elimination of vesting periods led to a sudden drop in executives’ departure costs. However, causality cannot be inferred by simply comparing executive turnover at accelerating and non-accelerating firms, because unobservable variables may have influenced both the acceleration decision and turnover. To overcome this challenge, we exploit that FAS 123-R’s compliance dates were staggered quasi-randomly across time by firms’ fiscal year-ends. We estimate the following 2SLS model for firm $$f$$ and fiscal year $$t$$:   \begin{align} {\textit{Option acceleration}}_{f,t} &= \pi_1 {\textit{FAS 123-R takes effect}}_{f,t} + \pi_2 X_{f,t} + \lambda_i + \mu_t + u_{f,t} \end{align} (First Stage)  \begin{align} {\textit{Executive turnover}}_{f,t+1} &= \gamma_1 \widehat{{\textit{Option acceleration}}}_{f,t} + \gamma_2 X_{f,t} + \lambda_i + \mu_t + \nu_{f,t} \end{align} (Second Stage) In this model, FAS 123-R takes effect$$_{f,t}$$ is our instrument for option acceleration, $$X_{f,t}$$ is a vector of firm characteristics, and $$\lambda_i$$ and $$\mu_t$$ are industry and year fixed effects. (We describe all variables in detail below.) Each regression contains two observations per firm: One for the fiscal year ending between January and December 2005, and one for the fiscal year ending between January and December 2006. All variables are measured at the firm-fiscal year level. The year fixed effect equals 1 for firm-fiscal year observations ending in calendar year 2005, and 0 for observations ending in calendar year 2006. Option acceleration$$_{f,t}$$ measures either whether a firm accelerated option vesting during a fiscal year, or what fraction of options it accelerated. FAS 123-R takes effect$$_{f,t}$$ equals 1 for firm-fiscal year observations ending between June 2005 and May 2006, and 0 for all other firm-fiscal year observations. (I.A. Table 3 exploits month-by-month variation in FAS 123-R compliance.) Table 3 Staggered FAS 123-R compliance, option acceleration, and CEO turnover    A. First-stage regressions  B. Reduced-form regressions  Dependent variable  Frac. options accelerated  Accelerate  CEO turnover  Voluntary CEO turnover  Voluntary CEO turnover (JKPW)  Executive turnover  Model  OLS  OLS  Sample  All firms  All firms  All firms  All firms  ExecuComp firms  All firms  Window of analysis  2005–2006  2005–2006     (1)  (2)  (3)  (4)  (5)  (6)  FAS 123-R takes effect  0.040***  0.145***  0.068***  0.052***  0.080***  0.041***     (8.15)  (11.13)  (5.30)  (4.25)  (4.24)  (4.73)  Log assets  –0.000  –0.001  0.024***  0.014***  0.008  0.027***     (–0.30)  (–0.37)  (7.40)  (4.94)  (1.37)  (13.62)  Market/book ratio  –0.001*  –0.002*  0.005***  0.003***  0.001  0.004***     (–1.91)  (–1.88)  (3.43)  (3.68)  (1.42)  (5.12)  Stock return  –0.043***  –0.110***  –0.012  0.019  –0.002  –0.028***     (–7.03)  (–8.94)  (–0.87)  (1.54)  (–0.08)  (–3.08)  Stock volatility  0.066*  0.087  0.089  –0.006  0.186  0.092*     (1.92)  (1.41)  (1.20)  (–0.10)  (1.15)  (1.81)  ROA  0.009  0.071***  –0.107***  –0.032  –0.269***  –0.005     (0.73)  (2.82)  (–3.49)  (–1.25)  (–3.16)  (–0.21)  Sales growth  0.001  –0.023  –0.042**  –0.009  –0.035  –0.031***     (0.19)  (–1.58)  (–2.33)  (–0.54)  (–0.87)  (–2.68)  CEO age under 61  –0.005  –0.016  0.002  0.010  0.069***        (–1.38)  (–1.64)  (0.19)  (0.97)  (3.82)     Non-compete clauses  0.000  –0.001  –0.005**  –0.005***  –0.008***  –0.003*     (0.18)  (–0.53)  (–1.97)  (–2.63)  (–2.68)  (–1.88)  Distance to peers  –0.000  0.000  –0.000  –0.000  –0.000  0.000     (–0.44)  (0.07)  (–0.52)  (–0.60)  (–1.24)  (0.26)  Frac. executives above 61                 –0.040***                    (–3.13)  Year fixed effects  Yes  Yes  Yes  Yes  Yes  Yes  Industry fixed effects  Yes  Yes  Yes  Yes  Yes  Yes  Observations  4,660  4,892  4,892  4,892  2,399  4,942  Adjusted $$R^2$$  0.082  0.132  0.025  0.014  0.022  0.058  F-Stat (FAS 123-R takes effect)  75.09  123.99                 A. First-stage regressions  B. Reduced-form regressions  Dependent variable  Frac. options accelerated  Accelerate  CEO turnover  Voluntary CEO turnover  Voluntary CEO turnover (JKPW)  Executive turnover  Model  OLS  OLS  Sample  All firms  All firms  All firms  All firms  ExecuComp firms  All firms  Window of analysis  2005–2006  2005–2006     (1)  (2)  (3)  (4)  (5)  (6)  FAS 123-R takes effect  0.040***  0.145***  0.068***  0.052***  0.080***  0.041***     (8.15)  (11.13)  (5.30)  (4.25)  (4.24)  (4.73)  Log assets  –0.000  –0.001  0.024***  0.014***  0.008  0.027***     (–0.30)  (–0.37)  (7.40)  (4.94)  (1.37)  (13.62)  Market/book ratio  –0.001*  –0.002*  0.005***  0.003***  0.001  0.004***     (–1.91)  (–1.88)  (3.43)  (3.68)  (1.42)  (5.12)  Stock return  –0.043***  –0.110***  –0.012  0.019  –0.002  –0.028***     (–7.03)  (–8.94)  (–0.87)  (1.54)  (–0.08)  (–3.08)  Stock volatility  0.066*  0.087  0.089  –0.006  0.186  0.092*     (1.92)  (1.41)  (1.20)  (–0.10)  (1.15)  (1.81)  ROA  0.009  0.071***  –0.107***  –0.032  –0.269***  –0.005     (0.73)  (2.82)  (–3.49)  (–1.25)  (–3.16)  (–0.21)  Sales growth  0.001  –0.023  –0.042**  –0.009  –0.035  –0.031***     (0.19)  (–1.58)  (–2.33)  (–0.54)  (–0.87)  (–2.68)  CEO age under 61  –0.005  –0.016  0.002  0.010  0.069***        (–1.38)  (–1.64)  (0.19)  (0.97)  (3.82)     Non-compete clauses  0.000  –0.001  –0.005**  –0.005***  –0.008***  –0.003*     (0.18)  (–0.53)  (–1.97)  (–2.63)  (–2.68)  (–1.88)  Distance to peers  –0.000  0.000  –0.000  –0.000  –0.000  0.000     (–0.44)  (0.07)  (–0.52)  (–0.60)  (–1.24)  (0.26)  Frac. executives above 61                 –0.040***                    (–3.13)  Year fixed effects  Yes  Yes  Yes  Yes  Yes  Yes  Industry fixed effects  Yes  Yes  Yes  Yes  Yes  Yes  Observations  4,660  4,892  4,892  4,892  2,399  4,942  Adjusted $$R^2$$  0.082  0.132  0.025  0.014  0.022  0.058  F-Stat (FAS 123-R takes effect)  75.09  123.99              The regressions contain all firm-fiscal year observations ending between January 2005 and December 2006, and all variables are measured at the firm-fiscal year level. Frac. options accelerated is the number of options accelerated during the fiscal year, divided by the number of options outstanding at the beginning of the fiscal year. Accelerate equals 1 if a firm accelerated option vesting during the fiscal year, and 0 in all other fiscal years. CEO turnover equals 1 if a firm experiences a CEO departure during the next fiscal year, and 0 in all other fiscal years. Voluntary CEO turnover equals 1 if a firm experiences a voluntary CEO departure during the next fiscal year, and 0 in all other fiscal years. Voluntary CEO turnover (JKPW) equals 1 if a firm experiences a voluntary CEO departure during the next fiscal year that is identified using the JKPW database, and 0 in all other fiscal years. Executive turnover is the number of executives departing during the next fiscal year divided by the total number of top executives. Our instrument FAS 123-R takes effect equals 1 for firm-fiscal year observations ending between June 2005 and May 2006, and 0 for all other firm-fiscal year observations. t-statistics, shown in parentheses, are based on standard errors that are clustered at the firm level. The year fixed effect equals 1 for firm-fiscal year observations ending in calendar year 2005, and 0 for firm-fiscal year observations ending in calendar year 2006. Industry fixed effects are based on the Fama-French 48 industry classification. F-Stat is the Kleibergen and Paap (2006) F-Statistic of our instrument FAS 123-R takes effect. ***, **, and * indicate significance levels of 1%, 5%, and 10%, respectively. The variable appendix provides the variable definitions. Table 3 Staggered FAS 123-R compliance, option acceleration, and CEO turnover    A. First-stage regressions  B. Reduced-form regressions  Dependent variable  Frac. options accelerated  Accelerate  CEO turnover  Voluntary CEO turnover  Voluntary CEO turnover (JKPW)  Executive turnover  Model  OLS  OLS  Sample  All firms  All firms  All firms  All firms  ExecuComp firms  All firms  Window of analysis  2005–2006  2005–2006     (1)  (2)  (3)  (4)  (5)  (6)  FAS 123-R takes effect  0.040***  0.145***  0.068***  0.052***  0.080***  0.041***     (8.15)  (11.13)  (5.30)  (4.25)  (4.24)  (4.73)  Log assets  –0.000  –0.001  0.024***  0.014***  0.008  0.027***     (–0.30)  (–0.37)  (7.40)  (4.94)  (1.37)  (13.62)  Market/book ratio  –0.001*  –0.002*  0.005***  0.003***  0.001  0.004***     (–1.91)  (–1.88)  (3.43)  (3.68)  (1.42)  (5.12)  Stock return  –0.043***  –0.110***  –0.012  0.019  –0.002  –0.028***     (–7.03)  (–8.94)  (–0.87)  (1.54)  (–0.08)  (–3.08)  Stock volatility  0.066*  0.087  0.089  –0.006  0.186  0.092*     (1.92)  (1.41)  (1.20)  (–0.10)  (1.15)  (1.81)  ROA  0.009  0.071***  –0.107***  –0.032  –0.269***  –0.005     (0.73)  (2.82)  (–3.49)  (–1.25)  (–3.16)  (–0.21)  Sales growth  0.001  –0.023  –0.042**  –0.009  –0.035  –0.031***     (0.19)  (–1.58)  (–2.33)  (–0.54)  (–0.87)  (–2.68)  CEO age under 61  –0.005  –0.016  0.002  0.010  0.069***        (–1.38)  (–1.64)  (0.19)  (0.97)  (3.82)     Non-compete clauses  0.000  –0.001  –0.005**  –0.005***  –0.008***  –0.003*     (0.18)  (–0.53)  (–1.97)  (–2.63)  (–2.68)  (–1.88)  Distance to peers  –0.000  0.000  –0.000  –0.000  –0.000  0.000     (–0.44)  (0.07)  (–0.52)  (–0.60)  (–1.24)  (0.26)  Frac. executives above 61                 –0.040***                    (–3.13)  Year fixed effects  Yes  Yes  Yes  Yes  Yes  Yes  Industry fixed effects  Yes  Yes  Yes  Yes  Yes  Yes  Observations  4,660  4,892  4,892  4,892  2,399  4,942  Adjusted $$R^2$$  0.082  0.132  0.025  0.014  0.022  0.058  F-Stat (FAS 123-R takes effect)  75.09  123.99                 A. First-stage regressions  B. Reduced-form regressions  Dependent variable  Frac. options accelerated  Accelerate  CEO turnover  Voluntary CEO turnover  Voluntary CEO turnover (JKPW)  Executive turnover  Model  OLS  OLS  Sample  All firms  All firms  All firms  All firms  ExecuComp firms  All firms  Window of analysis  2005–2006  2005–2006     (1)  (2)  (3)  (4)  (5)  (6)  FAS 123-R takes effect  0.040***  0.145***  0.068***  0.052***  0.080***  0.041***     (8.15)  (11.13)  (5.30)  (4.25)  (4.24)  (4.73)  Log assets  –0.000  –0.001  0.024***  0.014***  0.008  0.027***     (–0.30)  (–0.37)  (7.40)  (4.94)  (1.37)  (13.62)  Market/book ratio  –0.001*  –0.002*  0.005***  0.003***  0.001  0.004***     (–1.91)  (–1.88)  (3.43)  (3.68)  (1.42)  (5.12)  Stock return  –0.043***  –0.110***  –0.012  0.019  –0.002  –0.028***     (–7.03)  (–8.94)  (–0.87)  (1.54)  (–0.08)  (–3.08)  Stock volatility  0.066*  0.087  0.089  –0.006  0.186  0.092*     (1.92)  (1.41)  (1.20)  (–0.10)  (1.15)  (1.81)  ROA  0.009  0.071***  –0.107***  –0.032  –0.269***  –0.005     (0.73)  (2.82)  (–3.49)  (–1.25)  (–3.16)  (–0.21)  Sales growth  0.001  –0.023  –0.042**  –0.009  –0.035  –0.031***     (0.19)  (–1.58)  (–2.33)  (–0.54)  (–0.87)  (–2.68)  CEO age under 61  –0.005  –0.016  0.002  0.010  0.069***        (–1.38)  (–1.64)  (0.19)  (0.97)  (3.82)     Non-compete clauses  0.000  –0.001  –0.005**  –0.005***  –0.008***  –0.003*     (0.18)  (–0.53)  (–1.97)  (–2.63)  (–2.68)  (–1.88)  Distance to peers  –0.000  0.000  –0.000  –0.000  –0.000  0.000     (–0.44)  (0.07)  (–0.52)  (–0.60)  (–1.24)  (0.26)  Frac. executives above 61                 –0.040***                    (–3.13)  Year fixed effects  Yes  Yes  Yes  Yes  Yes  Yes  Industry fixed effects  Yes  Yes  Yes  Yes  Yes  Yes  Observations  4,660  4,892  4,892  4,892  2,399  4,942  Adjusted $$R^2$$  0.082  0.132  0.025  0.014  0.022  0.058  F-Stat (FAS 123-R takes effect)  75.09  123.99              The regressions contain all firm-fiscal year observations ending between January 2005 and December 2006, and all variables are measured at the firm-fiscal year level. Frac. options accelerated is the number of options accelerated during the fiscal year, divided by the number of options outstanding at the beginning of the fiscal year. Accelerate equals 1 if a firm accelerated option vesting during the fiscal year, and 0 in all other fiscal years. CEO turnover equals 1 if a firm experiences a CEO departure during the next fiscal year, and 0 in all other fiscal years. Voluntary CEO turnover equals 1 if a firm experiences a voluntary CEO departure during the next fiscal year, and 0 in all other fiscal years. Voluntary CEO turnover (JKPW) equals 1 if a firm experiences a voluntary CEO departure during the next fiscal year that is identified using the JKPW database, and 0 in all other fiscal years. Executive turnover is the number of executives departing during the next fiscal year divided by the total number of top executives. Our instrument FAS 123-R takes effect equals 1 for firm-fiscal year observations ending between June 2005 and May 2006, and 0 for all other firm-fiscal year observations. t-statistics, shown in parentheses, are based on standard errors that are clustered at the firm level. The year fixed effect equals 1 for firm-fiscal year observations ending in calendar year 2005, and 0 for firm-fiscal year observations ending in calendar year 2006. Industry fixed effects are based on the Fama-French 48 industry classification. F-Stat is the Kleibergen and Paap (2006) F-Statistic of our instrument FAS 123-R takes effect. ***, **, and * indicate significance levels of 1%, 5%, and 10%, respectively. The variable appendix provides the variable definitions. The first stage compares each firm’s acceleration decision (or amount of options accelerated) in the fiscal year just prior to FAS 123-R compliance to adjacent, control-period fiscal years. For late fiscal-year-end firms complying with FAS 123-R in calendar year 2005, the control group is firms with fiscal years ending between January and May 2005 that had not yet complied. For early fiscal-year-end firms complying in 2006, the control group is firms with fiscal years ending between June and December 2006 that had already complied. A positive value of $$\pi_1$$ would indicate that firms were more likely to accelerate option vesting (or to accelerate more options) during the fiscal year just prior to FAS 123-R compliance. We expect this because firms could only avoid expensing unvested options by eliminating vesting provisions prior to their compliance dates. Our instrument likely satisfies the exclusion restriction because firms did not anticipate that FASB would set FAS 123-R’s compliance schedule based on fiscal year-ends. The second stage regresses CEO or executive turnover during the next fiscal year on the fitted value of option acceleration from the first stage. A positive value of $$\gamma_1$$ would indicate that firms that accelerated vesting due to upcoming FAS 123-R compliance experienced higher turnover during the following fiscal year. We examine turnover over the next fiscal year because executives likely required a few months to identify preferable outside opportunities, yet our results are robust to using shorter horizons (see I.A. Table 4). Standard errors in the second stage are adjusted for the use of estimated regressors from the first stage, and the sample is identical to that of the first stage. Table 4 Effect of option acceleration on vested option holdings Dependent variable  Log vested option value  $$\Delta$$Log vested option value  Log vested option PPS  $$\Delta$$Log vested option PPS  Log vested option value  Log vested option PPS  Model Sample  OLS ExecuComp firms  Window of analysis  2003–2007  2005–2006  2003–2007  2005–2006  2003–2007  2003–2007     (1)  (2)  (3)  (4)  (5)  (6)  Accelerate  0.290**  0.340**  0.219***  0.247***  0.135  0.115     (2.19)  (2.02)  (2.82)  (2.86)  (1.02)  (1.43)  Accelerate$$\times$$CEO turnover              0.779*  0.514**                 (1.91)  (2.27)  CEO turnover              –0.611***  –0.325***                 (–5.36)  (–4.92)  Log assets  1.035***  0.084**  0.661***  0.048**  1.031***  0.659***     (5.63)  (2.00)  (6.11)  (2.08)  (5.74)  (6.22)  Market/book ratio  0.062**  –0.016**  0.037**  –0.009**  0.064**  0.038**     (2.13)  (–1.97)  (2.12)  (–2.08)  (2.32)  (2.29)  Stock return  0.818***  1.827***  0.526***  1.166***  0.786***  0.509***     (8.38)  (7.08)  (9.49)  (8.58)  (8.09)  (9.16)  Stock volatility  –0.642  3.410***  –2.054**  1.709***  –0.709  –2.085***     (–0.43)  (2.82)  (–2.50)  (2.96)  (–0.48)  (–2.58)  ROA  1.689***  –1.735**  1.062***  –0.961***  1.667***  1.058***     (3.26)  (–2.45)  (3.73)  (–2.76)  (3.26)  (3.76)  Sales growth  0.253  0.101  0.138  0.102  0.260  0.141     (1.30)  (0.32)  (1.23)  (0.65)  (1.39)  (1.31)  CEO age above 61  0.815***  –0.204*  0.586***  –0.140**  0.858***  0.609***     (5.02)  (–1.69)  (6.12)  (–2.08)  (5.26)  (6.33)  Year fixed effects  Yes  Yes  Yes  Yes  Yes  Yes  Industry fixed effects  No  Yes  No  Yes  No  No  Firm fixed effects  Yes  No  Yes  No  Yes  Yes  Observations  7,025  2,220  7,025  2,220  7,025  7,025  Adjusted $$R^2$$  0.052  0.049  0.060  0.070  0.060  0.067  Dependent variable  Log vested option value  $$\Delta$$Log vested option value  Log vested option PPS  $$\Delta$$Log vested option PPS  Log vested option value  Log vested option PPS  Model Sample  OLS ExecuComp firms  Window of analysis  2003–2007  2005–2006  2003–2007  2005–2006  2003–2007  2003–2007     (1)  (2)  (3)  (4)  (5)  (6)  Accelerate  0.290**  0.340**  0.219***  0.247***  0.135  0.115     (2.19)  (2.02)  (2.82)  (2.86)  (1.02)  (1.43)  Accelerate$$\times$$CEO turnover              0.779*  0.514**                 (1.91)  (2.27)  CEO turnover              –0.611***  –0.325***                 (–5.36)  (–4.92)  Log assets  1.035***  0.084**  0.661***  0.048**  1.031***  0.659***     (5.63)  (2.00)  (6.11)  (2.08)  (5.74)  (6.22)  Market/book ratio  0.062**  –0.016**  0.037**  –0.009**  0.064**  0.038**     (2.13)  (–1.97)  (2.12)  (–2.08)  (2.32)  (2.29)  Stock return  0.818***  1.827***  0.526***  1.166***  0.786***  0.509***     (8.38)  (7.08)  (9.49)  (8.58)  (8.09)  (9.16)  Stock volatility  –0.642  3.410***  –2.054**  1.709***  –0.709  –2.085***     (–0.43)  (2.82)  (–2.50)  (2.96)  (–0.48)  (–2.58)  ROA  1.689***  –1.735**  1.062***  –0.961***  1.667***  1.058***     (3.26)  (–2.45)  (3.73)  (–2.76)  (3.26)  (3.76)  Sales growth  0.253  0.101  0.138  0.102  0.260  0.141     (1.30)  (0.32)  (1.23)  (0.65)  (1.39)  (1.31)  CEO age above 61  0.815***  –0.204*  0.586***  –0.140**  0.858***  0.609***     (5.02)  (–1.69)  (6.12)  (–2.08)  (5.26)  (6.33)  Year fixed effects  Yes  Yes  Yes  Yes  Yes  Yes  Industry fixed effects  No  Yes  No  Yes  No  No  Firm fixed effects  Yes  No  Yes  No  Yes  Yes  Observations  7,025  2,220  7,025  2,220  7,025  7,025  Adjusted $$R^2$$  0.052  0.049  0.060  0.070  0.060  0.067  The regressions contain firm-fiscal year observations for ExecuComp firms that end between January 2003 and December 2007 (January 2005 and December 2007 in Columns 2 and 4). All variables are measured at the firm-fiscal-year level. Log vested option value is the natural logarithm of the Black-Scholes value of a CEO’s vested stock options at the end of the fiscal year. Log vested option PPS is the natural logarithm of the change in the dollar value of a CEO’s vested option holdings for a 1% change in the firm’s stock price. To single out the impact of option acceleration from other common changes to vested option holdings, we add back the value/PPS of options that are exercised during the fiscal year, and subtract the value/PPS of options that were scheduled to vest during the fiscal year. Accelerate equals 1 if a firm accelerated option vesting during the fiscal year, and 0 in all other fiscal years. CEO turnover equals 1 if a firm experiences a CEO departure during the next fiscal year, and 0 in all other fiscal years. t-statistics, shown in parentheses, are based on standard errors that are clustered at the firm level. Year fixed effects equal 1 for firm-fiscal year observations that end in the same calendar year. Industry fixed effects are based on the Fama-French 48 industry classification. ***, **, and * indicate significance levels of 1%, 5%, and 10%, respectively. The variable appendix provides the variable definitions. Table 4 Effect of option acceleration on vested option holdings Dependent variable  Log vested option value  $$\Delta$$Log vested option value  Log vested option PPS  $$\Delta$$Log vested option PPS  Log vested option value  Log vested option PPS  Model Sample  OLS ExecuComp firms  Window of analysis  2003–2007  2005–2006  2003–2007  2005–2006  2003–2007  2003–2007     (1)  (2)  (3)  (4)  (5)  (6)  Accelerate  0.290**  0.340**  0.219***  0.247***  0.135  0.115     (2.19)  (2.02)  (2.82)  (2.86)  (1.02)  (1.43)  Accelerate$$\times$$CEO turnover              0.779*  0.514**                 (1.91)  (2.27)  CEO turnover              –0.611***  –0.325***                 (–5.36)  (–4.92)  Log assets  1.035***  0.084**  0.661***  0.048**  1.031***  0.659***     (5.63)  (2.00)  (6.11)  (2.08)  (5.74)  (6.22)  Market/book ratio  0.062**  –0.016**  0.037**  –0.009**  0.064**  0.038**     (2.13)  (–1.97)  (2.12)  (–2.08)  (2.32)  (2.29)  Stock return  0.818***  1.827***  0.526***  1.166***  0.786***  0.509***     (8.38)  (7.08)  (9.49)  (8.58)  (8.09)  (9.16)  Stock volatility  –0.642  3.410***  –2.054**  1.709***  –0.709  –2.085***     (–0.43)  (2.82)  (–2.50)  (2.96)  (–0.48)  (–2.58)  ROA  1.689***  –1.735**  1.062***  –0.961***  1.667***  1.058***     (3.26)  (–2.45)  (3.73)  (–2.76)  (3.26)  (3.76)  Sales growth  0.253  0.101  0.138  0.102  0.260  0.141     (1.30)  (0.32)  (1.23)  (0.65)  (1.39)  (1.31)  CEO age above 61  0.815***  –0.204*  0.586***  –0.140**  0.858***  0.609***     (5.02)  (–1.69)  (6.12)  (–2.08)  (5.26)  (6.33)  Year fixed effects  Yes  Yes  Yes  Yes  Yes  Yes  Industry fixed effects  No  Yes  No  Yes  No  No  Firm fixed effects  Yes  No  Yes  No  Yes  Yes  Observations  7,025  2,220  7,025  2,220  7,025  7,025  Adjusted $$R^2$$  0.052  0.049  0.060  0.070  0.060  0.067  Dependent variable  Log vested option value  $$\Delta$$Log vested option value  Log vested option PPS  $$\Delta$$Log vested option PPS  Log vested option value  Log vested option PPS  Model Sample  OLS ExecuComp firms  Window of analysis  2003–2007  2005–2006  2003–2007  2005–2006  2003–2007  2003–2007     (1)  (2)  (3)  (4)  (5)  (6)  Accelerate  0.290**  0.340**  0.219***  0.247***  0.135  0.115     (2.19)  (2.02)  (2.82)  (2.86)  (1.02)  (1.43)  Accelerate$$\times$$CEO turnover              0.779*  0.514**                 (1.91)  (2.27)  CEO turnover              –0.611***  –0.325***                 (–5.36)  (–4.92)  Log assets  1.035***  0.084**  0.661***  0.048**  1.031***  0.659***     (5.63)  (2.00)  (6.11)  (2.08)  (5.74)  (6.22)  Market/book ratio  0.062**  –0.016**  0.037**  –0.009**  0.064**  0.038**     (2.13)  (–1.97)  (2.12)  (–2.08)  (2.32)  (2.29)  Stock return  0.818***  1.827***  0.526***  1.166***  0.786***  0.509***     (8.38)  (7.08)  (9.49)  (8.58)  (8.09)  (9.16)  Stock volatility  –0.642  3.410***  –2.054**  1.709***  –0.709  –2.085***     (–0.43)  (2.82)  (–2.50)  (2.96)  (–0.48)  (–2.58)  ROA  1.689***  –1.735**  1.062***  –0.961***  1.667***  1.058***     (3.26)  (–2.45)  (3.73)  (–2.76)  (3.26)  (3.76)  Sales growth  0.253  0.101  0.138  0.102  0.260  0.141     (1.30)  (0.32)  (1.23)  (0.65)  (1.39)  (1.31)  CEO age above 61  0.815***  –0.204*  0.586***  –0.140**  0.858***  0.609***     (5.02)  (–1.69)  (6.12)  (–2.08)  (5.26)  (6.33)  Year fixed effects  Yes  Yes  Yes  Yes  Yes  Yes  Industry fixed effects  No  Yes  No  Yes  No  No  Firm fixed effects  Yes  No  Yes  No  Yes  Yes  Observations  7,025  2,220  7,025  2,220  7,025  7,025  Adjusted $$R^2$$  0.052  0.049  0.060  0.070  0.060  0.067  The regressions contain firm-fiscal year observations for ExecuComp firms that end between January 2003 and December 2007 (January 2005 and December 2007 in Columns 2 and 4). All variables are measured at the firm-fiscal-year level. Log vested option value is the natural logarithm of the Black-Scholes value of a CEO’s vested stock options at the end of the fiscal year. Log vested option PPS is the natural logarithm of the change in the dollar value of a CEO’s vested option holdings for a 1% change in the firm’s stock price. To single out the impact of option acceleration from other common changes to vested option holdings, we add back the value/PPS of options that are exercised during the fiscal year, and subtract the value/PPS of options that were scheduled to vest during the fiscal year. Accelerate equals 1 if a firm accelerated option vesting during the fiscal year, and 0 in all other fiscal years. CEO turnover equals 1 if a firm experiences a CEO departure during the next fiscal year, and 0 in all other fiscal years. t-statistics, shown in parentheses, are based on standard errors that are clustered at the firm level. Year fixed effects equal 1 for firm-fiscal year observations that end in the same calendar year. Industry fixed effects are based on the Fama-French 48 industry classification. ***, **, and * indicate significance levels of 1%, 5%, and 10%, respectively. The variable appendix provides the variable definitions. Our model compares turnover rates among late fiscal-year-end firms following FAS 123-R compliance in calendar year 2005 to those of early fiscal-year-end firms that had not yet complied. It also compares turnover rates among early fiscal-year-end firms following compliance in calendar year 2006 to those of late fiscal-year-end firms that had already complied. Figure 1 illustrates this research design, showing that treatment and control groups consist of adjacent fiscal years, and switch over time based on the staggered FAS 123-R compliance schedule. One benefit of this design is that results cannot be explained by time-invariant differences between early and late fiscal-year-end firms. Our identification strategy also aims to control for some macroeconomic shocks that affect all firms at once. I.A. Figure 1 shows that for the specific case of May and June fiscal-year-end firms, the treatment and control periods almost completely overlap in calendar time. A contemporaneous shock would not explain turnover differences between these firms. However, our ability to account for such shocks is more limited than in this example, as it depends on the size of the gap (in calendar time) between firms’ fiscal year-ends. The vast majority of firms have a fiscal year ending in December, and these firms’ treatment periods overlap with control firms by five months or less.7 Our identification strategy thus only partially controls for shocks that coincide with FAS 123-R. Notably, our results are robust to excluding December fiscal-year-end firms. Moreover, we find no evidence that CEO departures are clustered in calendar time (see Figure 5), as one would expect if turnover is driven by a shock at a single point in time. Figure 5 View largeDownload slide Calendar-time variation in option acceleration and CEO turnover The sample contains 68 voluntary CEO departures following option acceleration. Each point plots the date at which options were accelerated and the announcement date of the CEO departure. Data on CEO departure dates are from Capital IQ. Figure 5 View largeDownload slide Calendar-time variation in option acceleration and CEO turnover The sample contains 68 voluntary CEO departures following option acceleration. Each point plots the date at which options were accelerated and the announcement date of the CEO departure. Data on CEO departure dates are from Capital IQ. 2.2.2 Validity of 2SLS assumptions Our instrument must satisfy two key assumptions to identify the causal effect of acceleration: Relevance condition: $$\pi_1 \ne 0$$. Our option acceleration measures are correlated with FAS 123-R takes effect$$_{f,t}$$ after controlling for other firm characteristics $$X_{f,t}$$. Exclusion restriction: $$Cov({\textit{FAS 123-R takes effect}}_{f,t}, \nu_{f,t}) = 0$$. Differences in FAS 123-R compliance dates across firms only affect turnover through their effect on option acceleration. Section 3 shows that firms were far more likely to accelerate options during the fiscal year immediately preceding FAS 123-R compliance, confirming the relevance condition. The exclusion restriction is satisfied if the determinants of turnover do not differ across early and late fiscal-year-end firms. We cannot test this condition for unobservable determinants, but Table 1 provides evidence for key observable variables. The table shows that differences in turnover rates are small and statistically insignificant prior to FAS 123-R. Stock and accounting performance and other firm characteristics are also statistically indistinguishable across fiscal year-ends. Additionally, executives of early and late fiscal-year-end firms had similar option holdings and annual pay packages. This indicates tha