Financial Statement Disclosure Accuracy: Evidence from Reported Stock Option Fair Values

• In Event: Are Financial Statements Useful?

Abstract

This study examines the internal consistency of employee stock option footnote disclosures. This setting allows us a unique opportunity to provide large sample evidence on the accuracy of a specific disclosure. We first document the frequency and magnitude of differences between (a) the reported weighted-average fair value for employee stock options granted and (b) the calculated option fair value using the disclosed weighted-average option model inputs and the Black-Scholes option pricing model. In a sample of 23,358 firm-year observations between 2004 and 2011, we find that 23.9 percent have reported and calculated option fair values that differ by more than ten percent, that these differences are material as a percentage of net income, and often persist from one year to the next. We then investigate potential explanations for these large and frequent differences and provide evidence that disclosure errors are the most important contributing factor. Finally, we provide evidence that the calculated value of options granted is positively associated with future stock option expense after controlling for the reported value of options granted, suggesting potential errors in the reported grant date fair values that may prevent investors from using these reported values to reliably estimate future stock option expense.

Authors

• Brian Bratten, University of Kentucky

• Ross Jennings, The University of Texas at Austin

• Casey M Schwab, The University of Georgia