Review of Quantitative Finance and Accounting, 10 (1998): 207–226
© 1998 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.
Companies’ Modest Claims About the Value of CEO
Stock Option Awards
Assistant Professor of Finance, Stern School of Business, New York University, 44 West 4th Street, Suite
9–160, New York, NY 10012. Email: firstname.lastname@example.org
Abstract. This paper analyzes company disclosures of CEO stock option values in compliance with the SEC’s
regulations for reporting executive compensation data to stockholders. Companies appear to exploit the ﬂex-
ibility of the regulations to reduce the apparent value of managerial compensation. Companies shorten the
expected lives of stock options and unilaterally apply discounts to the Black-Scholes formula. Theoretical
support for these adjustments is often thin, and companies universally ignore reasons that the Black-Scholes
formula might underestimate the value of executive stock options. The ﬁndings not only cast light upon how
corporations value executive stock options, but also provide a means of forecasting compliance with controver-
sial new FASB requirements for ﬁrms to disclose the compensation expense represented by executive stock
Key words: Executive stock option valuation, disclosure
In the early 1990s, public protests over the level of managerial compensation in large U.S.
companies led two government authorities to expand disclosure requirements for execu-
The most signiﬁcant new requirements of both the Securities and Exchange
Commission (SEC, 1992) and Financial Accounting Standards Board (FASB, 1995) in-
volve data about stock options used in executive compensation. Stock options have largely
fueled the growth in remuneration of American CEOs since the mid-1980s (Yermack,
1995). However, the limited data disclosed about these instruments under prior reporting
requirements was insufﬁcient to permit shareholders to value executives’ awards using
modern option-pricing methods.
This paper analyzes companies’ claims about the value of CEO stock option awards in
compliance with SEC disclosure requirements that became effective in late 1992 and were
augmented in 1993 (SEC, 1993a and b).
Because the SEC and FASB regulations allow
companies ﬂexibility in how to calculate the value of executive stock options, shareholder
activists have worried that ﬁrms will under-state the options’ expected cost to sharehold-
ers (Lowenstein, 1995; Siconolﬁ and Raghavan, 1996).
I test the hypothesis that companies report low levels of stock option compensation by
exploiting the ﬂexibility of the SEC’s new disclosure regulations. Using data for Fortune
500 companies, I analyze the claimed values of CEO stock option awards for those ﬁrms
that used the Black-Scholes (1973) approach as the basis of valuation. My hypothesis, that
@ats-ss3/data11/kluwer/journals/requ/v10n2art5 COMPOSED: 01/13/98 2:48 pm. PG.POS. 1 SESSION: 11