Accounting Papers

Document Type

Journal Article

Date of this Version

9-2012

Publication Source

Review of Accounting Studies

Volume

17

Issue

3

Start Page

526

Last Page

562

DOI

10.1007/s11142-012-9192-9

Abstract

This study examines how key market participants—managers and analysts—responded to SFAS 123R’s controversial requirement that firms recognize stock-based compensation expense. Despite mandated recognition of the expense, some firms’ managers exclude it from pro forma earnings and some firms’ analysts exclude it from Street earnings. We find evidence consistent with managers opportunistically excluding the expense to increase earnings, smooth earnings, and meet earnings benchmarks but no evidence that these exclusions result in an earnings measure that better predicts future firm performance. In contrast, we find that analysts exclude the expense from earnings forecasts when exclusion increases earnings’ predictive ability for future performance and that opportunism generally does not explain exclusion by analysts incremental to exclusion by managers. Thus our findings indicate that opportunism is the primary explanation for exclusion of the expense from pro forma earnings and predictive ability is the primary explanation for exclusion from Street earnings. Our findings suggest the controversy surrounding the recognition of stock-based compensation expense may be attributable to cross-sectional variation in the relevance of the expense for equity valuation, as well as to differing incentives of market participants.

Keywords

stock-based compensation, SFAS 123R, non-GAAP earnings, street earnings, pro forma earnings, earnings forecast exclusions, incentives

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Date Posted: 27 November 2017

This document has been peer reviewed.