The effects of SFAS-123R on corporate investment

ABSTRACT

This study examines the effects of mandatory expensing of stock options on corporate investment after the passage of SFAS-123R. First, we find an increase in corporate investment such as R&D investment and capital expenditure in the post-SFAS-123R period. Second, we find that stock-based compensation such as stock option compensation and restricted stock in the post-SFAS-123R period is positively related to investment. Our findings suggest that SFAS-123R discourages the opportunistic use of stock option compensation. The use of option compensation in the post-SFAS-123R era appears to encourage managers to pursue more long-term investment, which suggests that the SFAS-123R has had positive consequences.

KEYWORDS:

• SFAS-123R
• corporate investment
• stock options
• stock-based compensation

JEL CLASSIFICATION:

• M40
• M41
• G30
• G31

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Bergstresser and Philippon (2006) document high levels of accrual earnings management at firms whose CEOs have high stock option compensation. Bens, Nagar, and Wong (2002) report that high levels of stock option compensation are related to less real investment and more focus on share repurchase.

² Hayes, Lemmon, and Qiu (2012) document that accounting costs were the main driver of highly popular stock option compensation before SFAS-123R, but they find no evidence that the decrease in option compensation is related to less risky investment.

³ We define constant firms as firms having at least one firm year in both the pre- and post-SFAS-123R periods.

⁴ Following Chen, Liao, and Chi (2014), we use the fair value of a stock option based on the Black-Sholes model before SFAS-123R and the fair market value of stock option valued by firms after SFAS-123R.

⁵ Canace, Jackson, and Ma (2018) document that firms tend to maintain the same level of investment combining R&D expense and capital expenditure, and a large portion of increased capital expenditure is related to capitalized R&D expenditure.

⁶ Prior literature emphasizes the importance of combined investment between R&D and capital expenditure and documents that firms tend to maintain a similar level of overall investment (Bargeron, Lehn, and Zutter 2010; Canace, Jackson, and Ma 2018).