Impact Of Stock Options On Quarterly EPS: A Proposal For Change

Abstract

The purpose of this paper is to: 1) explore the annual and quarterly economic impact of FAS 123 on a group of S&P 100 firms; 2) propose changes in the measurement and disclosure rules of FAS 123; and 3) determine the annual and quarterly economic impact of these proposed changes on the same group of S&P 100 firms. While both FAS 123 and dynamic option expense measurement approaches have material economic impact and reduce the EPS amounts reported under APBO 25 rules approximately 16 percent or more, no statistically significant differences are found between the results of these two approaches in any year 2000 quarters. However, when the sample is split into two groups based on negative and positive quarterly returns, the differences between the results of the two methods are statistically significant for seven of eight quarterly observations. Compared to the static (FAS 123) measurement approach, the dynamic (quarterly recalculated) approach results in lower option expenses and higher EPS values for firms with declining stock prices and higher option expenses and lower EPS values for firms with increasing stock prices. Thus, the dynamic measurement approach proposed in this paper more faithfully represents the economic reality of individual firms.