steven balsam, austin l. reitenga, and jennifer yin · 2014. 5. 21. · annual meeting. we also...

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Accounting HorizonsVol. 22, No. 1March 2008pp. 23–45

Option Acceleration in Response toSFAS No. 123(R)

Steven Balsam, Austin L. Reitenga, and Jennifer Yin

SYNOPSIS: As of February 28, 2006, 958 publicly held companies accelerated thevesting of some or all of their employee stock options in advance of adopting SFASNo. 123(R). In doing so, these companies, on average, avoided $11.3 (8.4) million inpretax (after tax) expense, which represented 42 percent of prior year income. Inves-tors, in general, react positively to acceleration announcements as we find an averagecumulative abnormal return of about one-half of 1 percent for the three-day window(�1,1) surrounding the announcement, with the reaction positively associated with theexpense reduction that resulted from the acceleration, the declaration by the firm thatthe options accelerated are out of the money, return on assets, and firm size. Addi-tionally, we find that the decision to accelerate is positively associated with our estimateof the future expense related to unvested options; that is, the expense avoided be-cause of the acceleration. In contrast, the intrinsic value of unvested options; that is,the expense that would have to be recognized at the time of acceleration, firm profit-ability, and firm size (i.e., political visibility) are negatively associated with the decisionto accelerate. We interpret these results to indicate that managers consider the costs,as well as the benefits, in deciding whether to accelerate. Overall we conclude thatwhile accelerated vesting may be motivated by expense avoidance, it appears to bebeneficial to equity investors as evidenced by the positive abnormal returns associatedwith the announcement of the acceleration and the fact that abnormal returns arepositively associated with the expense avoided via acceleration.

INTRODUCTION

With the issuance of Statement of Financial Accounting Standard (SFAS) No.123(R): Accounting for Share-Based Payments, affected companies looked forways to minimize its impact on their financial statements. One of the more in-

novative approaches was option acceleration. While the details of option acceleration will

Steven Balsam is a Professor at Temple University, Austin L. Reitenga is an AssistantProfessor at The University of Alabama, and Jennifer Yin is an Associate Professor at TheUniversity of Texas at San Antonio.

We thank Jack Ciesielski of R. G. Associates for graciously providing us with data, Weal Aguir and LinxiaoLiu for their assistance in data collection, and participants at the American Accounting Association 2007Annual Meeting. We also acknowledge the helpful comments of David Ziebart (editor), and the two anonymousreviewers.

Submitted: June 2006Accepted: October 2007

Corresponding author: Steven BalsamEmail: [email protected]

24 Balsam, Reitenga, and Yin

Accounting Horizons, March 2008

be discussed below, the effect of option acceleration was to transfer an expense that wouldhave gone through the income statement post-adoption of SFAS No. 123(R), to the pre-adoption footnote disclosures. The benefits of keeping the expense off the income statementinclude a reduction in the risk of reporting negative earnings or negative earnings changesin the future, a reduction in the likelihood of violating debt covenants, and possibly areduction in the cost of capital.

In this article we examine the reaction of investors to the accelerations and factorsinfluencing the decision by companies to accelerate their unvested options. Using the four-factor model developed by Carhart (1997) to estimate abnormal returns, we find that in-vestors react positively to acceleration announcements.1 Additionally, we find that the de-cision to accelerate is positively associated with our estimate of the future expense relatedto unvested options, that is, the expense avoided because of the acceleration. In contrast,the intrinsic value of unvested options (i.e., the expense that would have to be recognizedat the time of acceleration), firm profitability in the year of acceleration, and firm size (i.e.,political visibility) are negatively associated with the decision to accelerate. We also findthat the market reaction to the acceleration event is positively associated with the expensereduction that resulted from the acceleration, the declaration by the firm that the optionsaccelerated are out of the money, return on assets, and firm size.

Our findings contribute to the line of research (for example, Carter and Lynch 2003,2007) showing how accounting considerations affect real transactions. In addition to beingof interest to academics, our research should interest users of accounting information andaccounting standard setters who must be aware that their decisions affect firm behavior. Inparticular, the Financial Accounting Standards Board (FASB) staff recommended that ac-celerations be treated as a nonsubstantive modification (FASB 2004a); if the board membersagreed to that position, it would have resulted in the options being expensed over theoriginal vesting period. However, the board elected to treat the acceleration as a substantivemodification, leading to the accelerations that we observed (FASB 2004b).

This article continues with the second section, which discusses the events leading upto the adoption of SFAS No. 123(R). The third section introduces option acceleration andprovides some descriptive information on the effect of accelerations. The fourth sectionpresents our empirical models, while the fifth section describes our data. The sixth sec-tion contains our cross-sectional analysis. The article concludes with a summary of resultsin the last section.

BACKGROUNDThe promulgation of SFAS No. 123(R) culminated 20 years of investigation and stan-

dard setting by the FASB on accounting for share-based payments. First put on the agendain 1984, an exposure draft mandating income statement recognition for share-based pay-ments using a fair-value-based method was issued in June 1993. In the face of overwhelm-ing opposition, the FASB backed down, issuing SFAS No. 123 in October 1995. SFAS No.123, while recommending recognition using the fair-value approach, only mandated foot-note disclosure of pro forma income amounts as if the fair-value method were used, allow-ing firms to continue to use the intrinsic value approach from Accounting Principles BoardOpinion No. 25 for the income statement.

1 Our results are robust to alternative estimation models (i.e., we also find a positive cumulative abnormal returnusing the market model).

Option Acceleration in Response to SFAS No. 123(R) 25


However, the financial scandals of the early twenty-first century (e.g., Enron,WorldCom), and the implication that stock options may have been a motivation, caused anumber of companies to consider changing their accounting for stock options. Toward themiddle of 2002 a large group of firms began announcing that they would voluntarily expensetheir options (see for example Balsam et al. 2006). In response to these voluntary adoptions,the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation—Transitionand Disclosure, in December 2002. At approximately the same time, in November 2002,shortly after the International Accounting Standards Board (IASB) issued a proposed In-ternational Financial Reporting Standard (IFRS) Share-Based Payment, the FASB issuedan Invitation to Comment, Accounting for Stock-Based Compensation: A Comparison ofFASB Statement No. 123, Accounting for Stock-Based Compensation, and Its Related In-terpretations, and IASB Proposed IFRS, Share-Based Payment. In March 2003 the FASBadded share-based payments to its agenda, and in February 2004, the IASB issued IFRSNo. 2, requiring that entities recognize an expense for all employee services received inshare-based payment transactions, using a fair-value-based method. The FASB issued theexposure draft for SFAS No. 123(R) in March 2004, and the final standard was issued inDecember 2004, effective for fiscal years beginning after June 15, 2005. Firms that had notyet adopted the recognition provisions of SFAS No. 123 grasped at ways to minimize itsimpact on future income, with a large number seizing on the FASB decision that acceler-ation of underwater stock options need not be recognized on the income statement.

THEORETICAL DEVELOPMENTOption acceleration is an interesting phenomenon, as it is a company’s unilateral waiver

of the vesting period on options given to employees. The waiver is not unique: corpora-tions in the past have unilaterally altered option contracts giving value to employees, forexample in repricing (for a discussion see Carter and Lynch 2003). Options normally havevesting periods, which provides a benefit to the company in ensuring they get the em-ployee’s services over the vesting period. To the employee, waiver of the vesting periodhas value, as he or she has the ability to leave the company without losing the intrinsicvalue of the options. Mitigating the value of the acceleration to the employee is the factthat the vast majority of the options involved were underwater; hence, while the employeecould exercise the options, it would not make sense to do so.2 Nonetheless, given thenonzero probability that share prices could increase and exceed the exercise price at sometime prior to the end of the vesting period,3 even for out-of-the-money options, employeesreceived and companies gave up something of value when they accelerated options. Whythen did the companies do so voluntarily?

The benefit to companies lies in the accounting treatment specified for options underSFAS No. 123 and No. 123(R). Briefly, under both SFAS No. 123 and No. 123(R) theoption’s cost is determined using the fair value (typically the Black-Scholes value) atthe date of grant, with the cost to be allocated over the vesting period. Thus, for an option

2 Of the 958 accelerations in our initial database, most (539) were on options out of the money, and 48 were onnew grants, which we assume were made at the money. Of the remaining accelerations we do not have infor-mation on 249, while 118 involved in-the-money options.

3 For example, Chance et al. (2000), in the context of option repricing, found that the majority of underwateroptions would have been at the money within two years.



that vests over a four-year period, the expense would be recognized equally over four years.While SFAS No. 123 permitted the disclosure of these costs in the footnotes, SFAS No.123(R) now requires income statement recognition. SFAS No. 123(R) expense recognitionnot only applies to options granted after its effective date, but also to unvested optionsgranted prior to its effective date. However, expense recognition for these unvested op-tions could be avoided by accelerating the vesting into the pre-adoption period. That is, theremaining cost of the accelerated options would be recognized in the footnote pro formaincome disclosure in the period of acceleration. These companies would then avoid rec-ognizing that expense in their income statement in the post-adoption period.4 To clarify,because these companies accelerated their options prior to adopting SFAS No. 123(R), theyrecognized the costs only in their pro forma income, not in their actual income statement.As an example, the Appendix contains an excerpt from the 8-K in which Alcoa disclosedits acceleration. The excerpt discloses that the acceleration:

was made primarily to avoid recognizing the related compensation cost in future financial statementsupon the adoption of Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004)‘‘Share-Based Payment,’’ which Alcoa will adopt on January 1, 2006, when it is required. Alcoaexpects the accelerated vesting of the 2004 and 2005 stock options to reduce its pre-tax stock optioncompensation expense in 2006 by approximately $35 million and in 2007 by approximately $10million.

Given that companies benefit from expense avoidance,5 why didn’t all companies ac-celerate? While companies can benefit, they may also incur costs. The costs to the companycan be accounting, nonaccounting, or both. If the options are in the money, the intrinsicvalue of the options is recognized in the income statement as an expense in the period ofacceleration. In addition, if the options are in the money, the employee could exercise theoptions immediately and potentially leave the company; thus, accelerating the options re-moves the motivational and/or bonding benefit from the option. However, given the nonzeroprobability that share prices could increase and exceed the exercise price at some time priorto the end of the vesting period, this cost exists even for out-of-the-money options. Overallwe expect that the incentive to accelerate options will be inversely related to the intrinsicvalue of the options.

The decision to accelerate could also be influenced by current year financial reportingconsiderations and factors affecting the firm’s sensitivity to future earnings declines. Forexample, current year profitability, debt covenants that are affected by reported income,and/or difficulty in meeting future earnings targets all should affect the likelihood ofacceleration.

EMPIRICAL MODELSWe run two cross-sectional models. In the first model we examine the choice to ac-

celerate, and in the second we examine the abnormal returns surrounding the acceleration.

4 Please note that the acceleration has no effect on either assets or equity; if the option had been expensed on theincome statement, the offsetting entry would have been to paid-in-capital.

5 This statement assumes that companies want to maximize reported income, which as we know is not alwaysthe case—for example, companies that want to reduce their political costs often try to minimize reported income(Watts and Zimmerman 1986). To illustrate, Hodder et al. (2006) in examining employee stock option valueestimates, found ‘‘a large proportion of firms exercise value-increasing discretion’’ that would have the effect ofreducing pro forma income.



Choice Model

Accelerator � � � � *Grant date Black-Scholes value of all unvested options0 1

� � *Intrinsic value of in-the-money unvested options2

� � *Percentage of shares held by top 5 executives3

� � *Percentage of shares held by outside directors4

� � *Percentage of shares held by institutions5

� � *Market-to-book ratio � � *Return on assets6 7

� � *Loss indicator � � *Debt-to-equity-ratio8 9

� � *Log of assets � � *Industry controls � ε.10 11 (1)

where:

Accelerator � 1 if the firm is identified as an accelerator in the R. G.Associates database, and 0 if it is a control firm;

Grant date Black-Scholes �value of all unvested

options

value of options estimated to be unvested divided bytotal assets at the end of 2004. We estimate as unvested25 percent of the options granted in 2001, 50 percent ofthe options granted in 2002, 75 percent of the optionsgranted in 2003, and 100 percent of the options grantedin 2004. The values are estimated from ExecuCompwherever possible, otherwise they are calculatedfollowing the procedures used by ExecuComp, e.g., theBlack-Scholes model, with data hand collected from10-Ks;6,7

Intrinsic value of in-the- �money unvested options

sum of the intrinsic value of all unvested options grantedfrom 2001–2004 divided by total assets at the end of2004. The value, which is the difference between theexercise price and the market price at the end of fiscal2004, is determined using data from ExecuCompwherever possible; otherwise the data is obtained from10-Ks;

Percentage of shares held by �top five executives

percentage of shares held by top five executives in 2004.Obtained from ExecuComp wherever possible, otherwisehand collected from proxy statements;

Percentage of shares held by �outside directors

percentage of shares held by outside directors in 2004.Obtained from The Corporate Library whenever possible,otherwise hand collected from proxy statements;

Percentage of shares held by �institutions

percentage of shares held by institutional investors in2004. Obtained from the CDA/Spectrum institutional(13-F) holding database;

6 We use four years because Kole (1997, 85) reported that ‘‘A typical vesting schedule includes a minimum waitto exercise of 12 months, after which one-quarter of the award is available for exercise; the remainder of theaward becomes available for exercise in equal installments over the next three years.’’

7 We use 2004 as our pre-acceleration year as most of our accelerations took place in 2005.



Market-to-book-ratio � market value of equity/total assets, both measured at theend of the 2004 fiscal year. Obtained from Compustat;

Return on assets � income before extraordinary items and discontinuedoperations divided by total assets measured in the yearof acceleration. Obtained from Compustat;

Loss indicator � indicator variable taking the value of 1 if the firm reportsa loss in the year of acceleration, and 0 otherwise.Obtained from Compustat;

Debt-to-equity-ratio � book value of long-term debt divided by book value ofcommon equity measured at the end of 2004. Obtainedfrom Compustat;

Log of assets � log of 2004 total assets. Obtained from Compustat; andIndustry controls � a series of indicator variables for two-digit SIC codes

that take the value of 1 if the firm is in a particularindustry, and 0 otherwise. Obtained from Compustat.

We expect a positive coefficient on our estimate of the grant date Black-Scholes valueof all unvested options, which is our proxy for the cost that has not yet been recognizedin the footnotes and would, post-SFAS No. 123(R), have to be recognized on the incomestatement.8,9 We expect that the greater this amount, the greater the benefit to accelerating.We include the intrinsic value of in-the-money unvested options which measures the amountof the expense that would have to be recognized in the income statement in the period ofacceleration for the following reason: If the options are in the money but not by very much,the current (accounting) cost may be minimal. In fact the amount charged to expenseimmediately under the intrinsic value method might be less than the amount charged underthe fair-value method required by SFAS No. 123(R). Conversely, the greater the intrinsicvalue the more likely the immediate charge to expense would be equal to or greater thanthe post-adoption SFAS No. 123(R) expense recognition, and thus the acceleration is lesslikely to give an accounting benefit. Consequently we expect a negative coefficient on thisvariable in the choice model.

We also include three ownership variables: percentage ownership by top five executives,percentage ownership by outside directors, and percentage ownership by institutions. Per-centage ownership by executives is a measure of the extent to which executives’ incentivesare aligned with those of shareholders (Jensen and Meckling 1976). Following Jensen andMeckling, the greater the executive ownership, the more likely managers are concernedover the value given up in the acceleration; thus we would expect a negative coefficient in

8 As discussed in note 6, we assume a four-year vesting period, with options vesting at a rate of 25 percent peryear. Paragraph 31 of SFAS No. 123 discusses the two ways to allocate cost in the case of this type of gradedvesting:

‘‘Compensation cost for an award with a graded vesting schedule shall be recognized in accordance with the method described inInterpretation 28 if the fair value of the award is determined based on different expected lives for the options that vest each year, asit would be if the award is viewed as several separate awards, each with a different vesting date. If the expected life or lives of theaward is determined in another manner, the related compensation cost may be recognized on a straight-line basis.’’

The method we follow is consistent with the straight-line option, which we assume most firms would follow,as under normal circumstances they would prefer to defer recognition of the cost.

9 In the choice model we use this variable because we can estimate it for both the accelerator and controlfirms. In the returns model, where we only use the acceleration firms, we use the company disclosed amounts,as we assume the companies’ estimates are better than ours. We note that for observations where we have bothvalues, there is a high positive correlation, 0.694, between our estimate and the firm disclosed amount.



the choice model. However, recent research (e.g., Burns and Kedia 2006; Bergstresser andPhilippon 2006; Cheng and Warfield 2005) finds that equity ownership provides incentivesfor earnings management. Consequently, while we include executive ownership as a controlvariable, we do not predict how it will affect the likelihood of acceleration.

Similarly we include director ownership as a measure of director involvement; however,we face the same quandary in making a prediction. Directors with significant investmentin the firm are more likely to take an active role. Better corporate governance may reducethe likelihood that the firm engages in an acceleration as in doing so it gives up the retentionvalue of the options without receiving anything in exchange. However, directors may suc-cumb to the same incentives as executives; they may avoid expense to preserve the valueof their investment. Consequently, we do not predict a sign for the ownership of outsidedirectors.

As a final measure of monitoring by outsiders, we include percentage of institutionalownership. Our belief is that the greater the level of monitoring, the less likely a firm willaccelerate unvested options. Alternatively, some research indicates that high levels of tran-sitory institutional ownership, that is, relatively small holdings by a large number of insti-tutions, can lead to more focus on meeting earnings forecasts (Bushee 1998). Institutionshaving relatively small holdings in a firm are likely to sell their shares if the firm does notperform well, rather than expend the resources to monitor and possibly attempt to replacemanagement. Thus we do not make any predictions for institutional ownership.

We include the market-to-book ratio to control for growth and its effect on acceleration.In particular we expect that growing firms, because of the greater penalties involved inmissing earnings growth targets (see for example Skinner and Sloan 2002), are more likelyto engage in accelerations. In a comparable situation, Carter and Lynch (2003) find thathigh growth firms were more likely to reprice options prior to a new accounting standardthat would have required expense recognition for the repriced options. Alternatively, be-cause of the mechanical relationship between the market-to-book ratio and the likelihoodof the options being underwater when the market price is low, firms with low market-to-book ratios may be more likely to accelerate, and we do not make a prediction for the signof the market-to-book ratio.

We include return on assets to control for the profitability of the firm in the accelerationyear. A long line of research (e.g., Lilien et al. 1988; Balsam et al. 1995) has shown thatprofitability is associated with accounting choices and that less profitable firms generallymake income-increasing accounting choices. Along those lines a less profitable firm mayhave a greater need to accelerate to avoid future expense recognition. Consequently weexpect a negative coefficient on this variable. We include a loss indicator as it is possiblethat firms anticipating negative income may be more likely to accelerate, even if it requiresimmediate expense recognition; that is, they might take a big bath.10 We expect a positivecoefficient on this variable. We include the debt-to-equity ratio to proxy for the closenessto debt covenant constraints, expecting to find a positive association with the accelerationdecision. We expect a negative coefficient on firm size as larger politically sensitive firmsmay be less likely to accelerate options. Finally we include indicator variables for two-digitSIC codes in our model to control for industry-fixed effects.

10 In contrast with our other independent variables, which use values measured at the end of fiscal 2004, wemeasure ROA and the existence of a loss in the year of the acceleration.



Returns Model

Cumulative Abnormal Returns

� � � � *Expense avoided via acceleration0 1

� � *Options accelerated are out of the money2

� � *Acceleration includes newly granted options3

� � *Executives and directors are primary beneficiaries of acceleration4

� � *Timing of acceleration � � *Return on assets5 6

� � *Debt-to-equity ratio � � *Log of assets � ε.7 8 (2)

where:

Cumulative abnormal returns � four-factor abnormal returns calculated respectively overthe window beginning one day before and ending oneday after the approval date, the date of announcement,and the extended window beginning one day before theapproval date and ending on the day after announcement;

Expense avoided via �acceleration

after-tax expense avoided via acceleration deflated bycommon equity—as reported by the accelerating firmsand included in the R. G. Associates database;

Options accelerated are out �of the money

indicator variable taking the value of 1 if the firmexplicitly states that all options accelerated were out ofthe money and 0 otherwise, as reported by theaccelerating firms and included in the R. G. Associatesdatabase;

Acceleration includes newly �granted options

indicator variable taking the value of 1 if the accelerationincludes newly granted options, and 0 otherwise, asreported by the accelerating firms and included in theR. G. Associates database;

Executives and directors are �primary beneficiaries of

acceleration

indicator variable taking the value of 1 if the company’sdisclosures, as reported in the R. G. Associates database,indicate that the majority of the shares accelerated arethose of executives and directors, and 0 otherwise;11

Timing of approval � firm rank from earliest to latest approval orannouncement of acceleration, as calculated;

Return on assets � income before extraordinary items and discontinuedoperations divided by total assets measured at the end of2004. Obtained from Compustat;

Debt-to-equity ratio � book value of long-term debt divided by book value ofcommon equity measured at the end of 2004. Obtainedfrom Compustat; and

11 Approximately half of the sample firms do not disclose the number of shares related to executives and directors.In our primary analysis we assume executives and directors are the primary beneficiaries of the acceleration inthese nondisclosure firms; that is, code the variable as 1, as we feel firms are less likely to disclose thisinformation when executives and directors are the primary beneficiaries. In unreported sensitivity tests we codethese observations as 0, finding that it does not affect the significance of any of our variables and that the modelbecomes slightly more significant.



Log of assets � log of 2004 total assets. Obtained from Compustat.12

We include expense avoided via acceleration to investigate whether the reaction to theacceleration and/or announcement is positively associated with the magnitude of the effect.If the benefit of the acceleration increases with the expense avoided as we expect, we willfind a positive coefficient on this variable. We include an indicator variable, options accel-erated are out of the money, because as discussed earlier, accelerations transfer value fromthe firm to the employee. This value is likely to be lower and the option is less likely tobe exercised and thereby lose its retentive effect when the options are out of the money.Consequently, we expect a positive coefficient on this variable. We include a second indi-cator variable, acceleration includes newly granted options, which represents optionsgranted on the same day as the acceleration and made immediately exercisable. While thecompany will avoid recognizing an expense for these options, given these options are atthe money, they are likely to be profitably exercisable earlier than out-of-the-money optionsand hence may lose their motivational/retentive impact sooner. Furthermore, because theyare granted and vested on the same day, they are more likely to be viewed as being theresult of managerial opportunism. Consequently, we expect a negative coefficient. We in-clude a third indicator variable that takes the value of 1 if executives and directors areprimary beneficiaries of the acceleration, which could signal managerial opportunism. Wealso expect a negative coefficient for this variable.

We include timing of approval as an independent variable to control for the possibilitythat the market reaction to accelerations changed over time. For example, the first accel-erations were more likely to be unexpected, and since investors had not seen accelerationsup until that point, they may not have known how to value them. We do not predict a signfor this variable. We include return on assets as a control variable because while a companythat is performing well may be seen as less likely to engage in an acceleration for oppor-tunistic purposes, they may also be seen as less likely to benefit from it. We include thedebt-to-equity ratio to control for the possibility that the benefit will be greater for firmscloser to their debt covenant constraints. We predict positive signs for both return on assetsand debt-to-equity ratio. Finally, we include log of assets to control for the effects of firmsize on the market reaction.

DATATable 1 describes our sample selection procedure and industry composition. The pop-

ulation of firms announcing their option accelerations as of February 28, 2006, was obtainedfrom R. G. Associates, who collected data on accelerators by setting up an alert in 10KWizard (http: / /www.10kwizard.com) that would then send them links to SEC filings men-tioning accelerated vesting. The alerts were set up to find 10-Ks, 10-Qs, and 8-Ks containingphrases such as immediately vested, accelerated the vesting, approved the vesting, and othersimilar phrases. They also set up news alerts in Yahoo News and Google News to findcompany press releases mentioning accelerations. Their database consisted of 958 accel-erations by 848 unique companies spanning the period June 10, 2004, through February28, 2006. We merged this database with CRSP, from which we obtained stock returns, andStandard & Poor’s (S&P) Compustat and ExecuComp, from which we obtained financialand executive compensation variables. We also obtained data on Institutional Holdings from

12 In contrast with our choice model, we do not include industry-fixed effects in our returns models. However,including industry-fixed effects does not affect our conclusions.

http://www.10kwizard.com

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TABLE 1Sample Selection Procedure and Industry Distribution

Panel A: Sample Selection ProcedureChoice Model Returns ModelNo. of Firms No. of Observations

R. G. Associates Data 848 958Less: Firms/Observations Announced Accelerations in 2006 (104) (117)Less: Firms/Observations Not in Compustat (18) (21)Less: Firms/Observations with Missing Data (336) (330)Firms/Observations Used in Analysis 390 490

Panel B: Sample Partitioned by Industry

SIC Codes Division Name

Compustat SampleNo. ofFirms Percent

Full SampleNo. ofFirms Percent

Choice SampleNo. ofFirms Percent

Returns SampleNo. ofObs. Percent

1000–1499 Mining 236 3.38 7 0.85 3 0.77 2 0.411500–1799 Construction 32 0.46 3 0.36 2 0.51 1 0.212000–3999 Manufacturing 2,668 38.27 379 45.66 200 51.28 229 46.734000–4999 Transportation, Communications,

Electric, Gas and Sanitary Services723 10.37 48 5.78 21 5.39 29 5.92

5000–5199 Wholesale Trade 216 3.10 19 2.29 13 3.33 15 3.065200–5999 Retail Trade 343 4.92 46 5.54 21 5.39 25 5.106000–6799 Finance, Insurance, and Real Estate 1,418 20.34 142 17.11 47 12.05 76 15.517000–8899 Services 1,239 17.77 185 22.29 83 21.28 113 23.069100–9999 Public Administration 97 1.39 1 0.12 0 0.00 0 0.00

Total 6,972a 100 830b 100 390 100 490 100

a These are firms with nonmissing assets data in the Compustat database.b 18 firms in the R. G. Associates Data are not in the Compustat database.



the CDA/Spectrum Institutional (13-F) Holding database and board ownership from TheCorporate Library.

While CRSP and Compustat are fairly broad in their coverage, ExecuComp and TheCorporate Library focus their respective coverage on the S&P 500, S&P MidCap, and S&PSmallCap indices. Limiting our sample to those firms would result in a loss of approxi-mately 80 percent of the population of accelerators. Therefore, we supplement the datafrom the databases above with hand-collected data from 10-Ks and proxy statements. Byhand collecting data we more than doubled our sample size.

Because the data requirements differ between our choice and returns models, and be-cause the choice model is run by firm, whereas the returns model is based on number ofobservations, and several firms had more than one acceleration, the sample sizes differsomewhat. The choice model includes 390 accelerating and 623 control firms, whereasthe returns model includes 490 accelerating events. We do not include control firmsin our returns model as we only analyze the cross-sectional abnormal returns for theaccelerators.

As shown in Panel A of Table 1, in the choice (returns) model we lose 104 firms (117observations) because we restrict our sample to firms that made announcement prior toDecember 31, 2005. Additionally, we lose 18 firms (21 observations) that were not availableon Compustat. We lose the largest number of firms (observations), 336 (330), because ofincomplete data, primarily information on the expense avoided via acceleration.13 Our con-trol sample for the choice model consists of all ExecuComp nonaccelerating firms withsufficient data for our test. We limit control firms to ExecuComp firms to minimize the costinvolved with hand collection of data. However, the fact that our 623 control sample isentirely made up of ‘‘larger’’ ExecuComp firms has the potential to create a bias in ouranalysis. Consequently, we rerun our analysis limiting the accelerator sample to only firmson ExecuComp, and in untabulated results find our conclusions are identical to those pre-sented in the article.

Panel B shows the industry distribution for the original sample, as well as for thesamples used in our choice and returns models. When we compare the original sample tothe Compustat population we find some overrepresentation in the manufacturing (SIC codes2000–3999) and service (SIC codes 7000–7999) industries, the two largest industries interms of acceleration use. We also find some underrepresentation in the finance, insurance,and real estate (SIC codes 6000–6999) and transportation, communication, electric, gas,and sanitary services (SIC codes 4000–4999). In each of these cases the difference betweenthe sample and population proportions is statistically significant. Consequently, in our em-pirical analysis below we control for industry classification.

Not every company in our database reported the amount of cost avoided by accelerating,but of those that did, the average expense avoided was $11 million before tax and $8.4million after tax (see Table 2). As a benchmark for gauging the materiality of thisamount, the after-tax expense avoided was 42 percent of prior year income for firms withpositive income, 1 percent of beginning of the year assets, and 2 percent of beginningcommon equity. In addition, on average our sample firms accelerated 2.2 million shares ofoptions.

13 Our estimate of this amount, which is required for both the accelerator and control firms, requires, as discussedbelow, data on option grants from 2001–2004.



TABLE 2Descriptive Statistics (n � 490)

Variable MeanFirst

Quartile MedianThird

QuartileStandardDeviation

PreTax Expense Avoided ($ millions) 11.330 1.000 3.000 8.600 29.155After-Tax Expense Avoided ($ millions) 8.351 0.715 2.145 6.110 23.023After-Tax Expense Avoided

Absolute Value Of Prior Year Income0.407 0.042 0.116 0.292 1.563

After-Tax Expense AvoidedPrior Year Incomea

0.420 0.040 0.108 0.276 1.778

After-Tax Expense AvoidedBeginning Total Assets

0.014 0.002 0.007 0.017 0.024

After-Tax Expense AvoidedBeginning Common Equity

0.024 0.006 0.013 0.028 0.030

Number of Options Accelerated(millions)

2.162 0.306 0.770 1.769 4.813

a After deleting firms with losses.

RESULTSChoice Model

Table 3 presents the results of our logistical regression. For this analysis we use the390 observations identified in Table 1 as our test sample, and all other firms (623) inExecuComp meeting our data requirements as our control sample. We present descriptivedata for these firms in Panel A of the table and regression results in Panel B. Examiningthe descriptive statistics in Panel A, we see that except for the debt-to-equity ratio, allof the variables are statistically different between acceleration firms and control firms. Asexpected, the grant date Black-Scholes value of all unvested options is higher for acceler-ating firms, consistent with acceleration being more likely when the benefits are high. Alsoconsistent with our expectations, we find accelerating firms are more likely to report a lossin the year of the acceleration. Similarly, consistent with expectations, we find acceleratorfirms are smaller and less profitable; that is, they report lower return on assets. In contrastwith expectations, the intrinsic value of in-the-money unvested options, (the amount thatwould have to be recognized on the income statement as an expense in the period ofacceleration) is higher for accelerating firms. We also find that accelerators have lowerinside and institutional ownership, but higher ownership by outside directors. Finally wefind that accelerating firms have a higher market-to-book ratio.

Turning to our logistical analysis, Panel B provides three slightly different analyses. Inthe first analysis, we run model (2) as presented above; whereas in the second analysis wedelete the loss variable, and in the third analysis we incorporate both the loss variable plusan interaction between the loss variable and the intrinsic value of in-the-money unvestedoptions. The justification for the latter formulations revolves around the fact that firmsreporting losses have different incentives. Thus in the second analysis we delete allfirms reporting losses; that is, we run our analysis only on profitable firms. In the thirdanalysis we retain loss firms but recognize that a firm in a loss situation may not care abouttaking the immediate expense associated with the acceleration of in-the-money options; for

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TABLE 3Logit Analysis of Decision to Accelerate

Panel A: Descriptive Statisticsa

VariablePredictedDifference

Accelerator Sample(n � 390)

Mean Std. Dev.

Control Sample(n � 623)

Mean Std. Dev.Difference

p-value

Grant Date Black-Scholes Value of All UnvestedOptions (deflated by lagged total assets)

� 0.083 0.086 0.039 0.059 0.000***

Intrinsic Value of In-the-Money Unvested Options(deflated by lagged total assets)

� 0.030 0.053 0.022 0.043 0.009***

Percentage of Shares Held by Top 5 Executives � /� 1.216 2.839 1.701 2.915 0.009***Percentage of Shares Held by Outside Directors � /� 4.934 6.505 2.381 4.840 0.000***Percentage of Shares Held by Institutions � /� 63.758 26.793 77.666 17.838 0.000***Market-to-Book Ratio � /� 1.705 1.103 1.423 1.068 0.001***Return on Assets � 0.324 10.286 5.745 7.114 0.000***Loss Indicator � 0.302 0.459 0.086 0.281 0.000***Debt-to-Equity Ratio � 0.614 1.247 0.703 1.217 0.263Log of Assets � 4.863 2.720 8.042 1.707 0.000***

a The 390 firms are all of the accelerator firms identified by R. G. Associates that have the required data (see Table 1 for a more detailed description of the acceleratorfirms). The 623 control firms are all ExecuComp firms with the required data that were not identified by R. G. Associates as accelerator firms.

(continued on next page)

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TABLE 3 (continued)

Panel B: Choice Model

Accelerator � � � � *Grant date Black-Scholes value of all unvested options � � *Intrinsic value of in-the-money unvested options0 1 2

� � *Percentage of shares held by top 5 executives � � *Percentage of shares held by outside directors3 4

� � *Percentage of shares held by institutions � � *Market-to-book ratio � � *Return on assets � � *Loss indicator5 6 7 8

� � *Debt-to-equity ratio � � *Log of assets � � *Industry controls � ε.9 10 11

Variable Predicted Sign Coef. p-value Coef. p-value Coef. p-value

Intercept � /� 7.204 �0.001*** 7.934 �0.001*** 7.238 �0.001***Grant Date Black-Scholes Value of All Unvested

Options� 4.390 0.019** 6.600 0.005*** 4.400 0.018**

Intrinsic Value of In-the-Money Unvested Options � �5.960 0.023** �6.425 0.043** �5.401 0.056*Percentage of Shares Held by Top 5 Executives � /� �1.953 0.508 1.967 0.537 �1.918 0.516Percentage of Shares Held by Outside Directors � /� 0.910 0.615 0.280 0.894 0.906 0.617Percentage of Shares Held by Institutions � /� �0.503 0.326 �1.027 0.084* �0.511 0.318Market-to-Book Ratio � /� 0.061 0.653 0.172 0.315 0.064 0.638Return on Assets � �0.045 0.019** �0.102 0.001*** �0.047 0.016**Loss Indicator � �0.129 0.736 �0.086 0.825Intrinsic Value of In-the-Money Unvested Options

*Loss Indicator� �2.623 0.587

Debt-to-Equity Ratio � 0.033 0.680 0.196 0.054* 0.030 0.708Log of Assets � �0.657 �0.001*** �0.699 �0.001*** �0.657 �0.001***

n 1013 841c 1013Likelihood Ratio Prob � Chi-squared 0.000 0.000 0.000Pseudo R2 0.384 0.375 0.385Pearson Goodness-of-Fit Chi-squared 0.439a 0.020 0.403a

Hosmer-Lemeshow Goodness-of-Fit Chi-squared 0.047a 0.045a 0.109a

ROC curve 0.870b 0.858b 0.871b


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TABLE 3 (continued)

*, **, *** Significant at the 10 percent, 5 percent, and 1 percent levels, respectively, based on two-tailed tests.a An insignificant p-value indicates that the model does not significantly differ from a model that perfectly predicts accelerations.b A ROC curve of 0.70–0.80 indicates an acceptable model, and greater than 0.80 is an excellent model (Hosmer and Lemeshow 2000).c Loss firms are omitted from the regression.Industry fixed-effect coefficients are omitted from the table.All variables are winsorized at two standard deviations to alleviate the influence of outliers.Variable Definitions:

Accelerator � 1, if the firm is identified as an accelerator in the R. G. Associates database and 0 if it is a control firm;Grant date Black-Scholes value of all unvested options � value of options estimated to be unvested divided by total assets at the end of 2004. We estimate as unvested

25 percent of the options granted in 2001, 50 percent of the options granted in 2002, 75 percent of theoptions granted in 2003, and 100 percent of the options granted in 2004. The values are estimated fromExecuComp wherever possible; otherwise they are calculated following the procedures used by ExecuComp,e.g., the Black-Scholes model, with data hand-collected from 10-Ks;

Intrinsic value of in-the-money unvested options � sum of the intrinsic value of all unvested options granted from 2001–2004 divided by total assets at the endof 2004. The value, which is the difference between the exercise price and the market price at the end offiscal 2004, is determined using data from ExecuComp wherever possible; otherwise the data is obtainedfrom 10-Ks;

Percentage of shares held by top 5 executives � percentage of shares held by top 5 executives in 2004. Obtained from ExecuComp wherever possible,otherwise hand-collected from proxy statement;

Percentage of shares held by outside directors � percentage of shares held by outside directors in 2004. Obtained from the Corporate Library wheneverpossible, otherwise hand-collected from proxy statement;

Percentage of shares held by institutions � percentage of shares held by institutional investors in 2004. Obtained from the CDA/Spectrum institutional(13-F) holding database;

Market-to-book ratio � market value of equity / total assets, both measured at the end of the 2004 fiscal year. Obtained fromCompustat;

Return on assets � income before extraordinary items and discontinued operations divided by total assets measured in the yearof acceleration. Obtained from Compustat;

Loss indicator � indicator variable taking the value of 1 if the firm reports a loss in the year of acceleration, 0 otherwise.Obtained from Compustat;

Debt-to-equity ratio � book value of long-term debt divided by book value of common equity measured at the end of 2004.Obtained from Compustat;

Log of assets � log of 2004 total assets. Obtained from Compustat; andIndustry controls � a series of indicator variables for two-digit SIC codes that take the value of 1 if the firm is in a particular

industry and 0 otherwise. Obtained from Compustat.



example, it may take a big bath, so the existence of a loss may only affect the decision toaccelerate if the options are in the money.

All of the models are statistically significant (p � 0.000) and the pseudo R2 rangesfrom 37.5 to 38.5 percent. Using a 50 percent cutoff, the models classify between 82 and84 percent of the observations correctly. In assessing the strength of the logistical model,we performed three goodness-of-fit analyses. First, we performed the Pearson Chi-squaredgoodness-of-fit test. The insignificant p-values of 0.439 and 0.403 in the first and thirdmodels indicate that the model does not significantly differ from a model that perfectlypredicts accelerations. In contrast we find a p-value of 0.020 for the second model, whichindicates there is some concern about the model. The p-values of the Hosmer andLemeshow (2000) goodness-of-fit tests are significantly different from 0 in the firstand second models, suggesting that the models differ from a model that perfectly predictsaccelerations. Finally, we calculate the Receiver Operator Characteristics (ROC) curve. Wefind that 85 to 87 percent of the area falls under the ROC curve. For comparison purposes,50 percent of the area would fall under the ROC curve for a model with no predictivepower. Hosmer and Lemeshow (2000) classify a model with 80–90 percent of the areaunder the ROC curve as an ‘‘excellent’’ model. While some diagnostic tests suggest poten-tial problems, particularly for the second model, the majority of the diagnostic tests suggestthat the models are well specified.

We focus our discussion on the first model, as the primary results are consistent acrossmodels. In that model we find that four of our ten variables are statistically significant atp � 0.10 or better. As expected, the grant date Black-Scholes value of all unvested optionsis positive and strongly significant (p � 0.019). Also as expected, the intrinsic value of in-the-money unvested options is negative and significant (p � 0.023). This indicates that theamount of expense that can be avoided is a motivation for acceleration, while the amountthat must be recognized immediately is a deterrent to accelerating.

We find that ROA is negative and significant (p � 0.019), indicating that more profitablefirms are less likely to accelerate. We also find that firm size has a negative and stronglysignificant association with acceleration (p � 0.001), consistent with large, politically vis-ible firms being less likely to accelerate. The coefficients on our ownership variables areinsignificant, as are those on the market-to-book ratio, return on assets, and debt-to-equityratio.

Returns ModelIn Panel A of Table 4 we provide descriptive data on the market reaction to accelera-

tions. Using the four-factor model developed by Carhart (1997) that takes into accountexcess return on the market, value versus growth, large versus small market capitalization,and the momentum factor, we examine abnormal returns for the three-day windows (�1,�1) surrounding the acceleration approval and announcement dates, and the extended win-dow beginning one day prior to the date of the approval and ending one day after theannouncement of the acceleration. We use three windows because it is unclear whenthe market has information on and, consequently, reacts to the acceleration.14 We find apositive and significant mean abnormal return of 0.524 percent (p-value � 0.005) for thethree-day window surrounding the announcement and insignificant abnormal returns for

14 The mean (median) distance between the date of approval and date of announcement is 14 (five) days.

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TABLE 4Four-Factor Cumulative Abnormal Returnsa

Panel A: Market Reaction to Accelerations

Window Abnormal Return p-value

Approval Date (�1,�1) �0.065% 0.695Announcement Date (�1, �1) 0.524% 0.005***One Day Prior to the Approval Date Through

One Day After the Announcement Date0.629% 0.122

Panel B: Descriptive Statistics (n � 490)

Variable MeanFirst

Quartile MedianThird

QuartileStandardDeviation

Expense Avoided via Acceleration (After-tax expense avoided/beginningcommon equity)

0.024 0.006 0.013 0.028 0.030

Options Accelerated are Out of the Money 0.641 0 1 1 0.480Acceleration Includes Newly Granted Options 0.020 0 0 0 0.142Executives and Directors are Primary Beneficiaries of Acceleration 0.180 0 0 0 0.384Return on Assets 0.006 �0.004 0.023 0.067 0.125Debt-to-Equity Ratio 0.557 0.000 0.146 0.583 1.106Log of Assets 6.022 4.881 5.974 7.181 1.612


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TABLE 4 (continued)

Panel C: OLS Regression (n � 490)

Cumulative Abnormal Returns� � � � *Expense avoided via acceleration � � *Options accelerated are out of the money0 1 2

� � *Acceleration includes newly granted options � � *Executives and directors are primary beneficiaries of acceleration3 4

� � *Timing of acceleration � � *Return on assets � � *Debt-to-equity ratio � � *Log of assets � ε.5 6 7 8

VariablePredicted

Sign

Announcement Date(A)

Coefficient p-value

Approval Date(B)

Coefficient p-value

Extended Window(C)

Coefficient p-value

Intercept � /� �0.029 0.01*** �0.020 0.04** �0.057 0.02**Expense Avoided via Acceleration � 0.267 �0.01*** 0.148 0.01*** 0.423 0.01***Options Accelerated are Out of the Money � 0.008 0.06* 0.009 0.01*** 0.010 0.26Acceleration Includes Newly Granted Options � 0.017 0.19 0.008 0.50 �0.028 0.33Executives and Directors are Primary

Beneficiaries of Acceleration� 0.007 0.15 0.007 0.14 0.020 0.08*

Timing of Approval � /� 0.0002 0.19 0.00004 0.73 0.0001 0.75Return on Assets � 0.029 0.07* 0.038 0.03** 0.092 0.04**Debt-to-equity Ratio � �0.001 0.44 �0.0002 0.88 �0.005 0.21Log of Assets � /� 0.003 0.02** 0.001 0.34 0.007 0.02**

Prob � F 0.00*** 0.02** 0.01***Adjusted R2 3.32% 1.93% 2.37%


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TABLE 4 (continued)

*, **, *** Significant at the 10 percent, 5 percent, and 1 percent levels, respectively, based on two-tailed tests.a The announcement date is the date the acceleration was first disclosed to the public, normally via an SEC filing. The approval date is the date the board approved the

acceleration, and the extended window begins one day prior to the acceleration approval by the board and ends one day after its public disclosure.All variables are winsorized at two standard deviations to alleviate the influence of outliers.Variable Definitions:

Cumulative abnormal returns � four-factor abnormal returns (Carhart 1997) calculated respectively over the window beginning oneday before and ending one day after, the approval date, the date of announcement, and theextended window beginning one day before the approval date and ending one day afterannouncement;

Expense avoided via acceleration � after-tax expense avoided via acceleration deflated by beginning common equity, as reported by theaccelerating firms and included in the R. G. Associates database;

Options accelerated are out of the money � indicator variable taking the value of 1 if the firm explicitly states that all options accelerated wereout of the money and 0 otherwise, as reported by the accelerating firms and included in the R. G.Associates database;

Acceleration includes newly granted options � indicator variable taking the value of 1 if the acceleration includes newly granted options and 0otherwise, as reported by the accelerating firms and included in the R. G. Associates database;

Executives and directors are primary beneficiaries of acceleration � indicator variable taking the value of 1 if the company’s disclosures, as reported in the R. G.Associates database, indicate that the majority of the shares accelerated are those of executives anddirectors, and 0 otherwise;

Timing of approval � firm rank from earliest to latest approval or announcement of acceleration, as calculated;Return on assets � income before extraordinary items and discontinued operations divided by total assets measured at

the end of 2004. Values obtained from Compustat;Debt-to-equity ratio � book value of long-term debt divided by book value of common equity measured at the end of

2004. Values obtained from Compustat; andLog of assets � log of 2004 total assets. Obtained from Compustat.



the approval date and the extended window.15 The former provides some evidence thatshareholders believe accelerations to be good news, suggesting that the benefits derivingfrom expense avoidance more than offset the costs associated with option acceleration. Thiscould be because of a reduction in the risk of reporting negative earnings or negativeearnings changes in the future, a reduction in the likelihood of (future) violating debtcovenants, and possibly a reduction in the cost of capital.

Panel B of Table 4 presents descriptive statistics for the independent variables in ourreturn analysis, while Panel C presents our empirical analysis. We run this model threetimes, using alternatively the abnormal returns surrounding the acceleration approval date,announcement date, and the extended window encompassing both the acceleration approvaland announcement dates as dependent variables.16 We use the window surrounding theacceleration approval date and the extended window as alternative dependent variables;even though we observe no average abnormal returns significantly different from 0 in thesewindows, cross-sectional variation may still exist in the returns.

The models are shown in columns A through C of Panel C. Each is statistically sig-nificant with p-values ranging from �0.01 to 0.02, and the adjusted R2 ranges from 1.93to 3.32 percent, with the model for the announcement date having both the most significantp-value and the highest R2. While the inferences are similar across the three models,the discussion of results will focus on the model using the announcement date as thedependent variable. The amount of the expense avoided via acceleration is positive andstrongly significant (p � 0.01), which indicates that shareholders react positively to themagnitude of the benefit. Similarly we observe a positive and significant (p � 0.06) coef-ficient on the indicator variable options accelerated are out of the money, which is consistentwith the market viewing these accelerations as less costly. We also observe positive andsignificant coefficients on return on assets (p � 0.07) and log of assets (p � 0.02). Thecoefficients on acceleration includes newly granted options, executives and directors areprimary beneficiaries of the acceleration, timing of approval, and debt-to-equity ratioare not significantly different from 0.

CONCLUSIONSIn this article we have provided some descriptive information on option accelerators,

as well as examined and explained the market reaction to accelerations and the choice byfirms to accelerate. As we note, a large group of 958 publicly traded firms accelerated their

15 Choudhary et al. (2007) and Elayan et al. (2006) also examined the market reaction to acceleration announce-ments, but found different results. The former found negative abnormal returns around the announcement date,while the latter found mostly insignificant returns around the announcement date. We examined whether differ-ences in underlying assumptions could explain the difference in findings, including trying the following alter-natives: (1) market indexes. We used the value-weighted market index, the equally-weighted market index, andthe Russell 2000 index (as in Choudhary et al. 2007) and consistently found significant and positive CAR (�1,1)surrounding the announcement date. (2) Models. We replaced the four-factor model with the standard marketmodel and found similar results as reported in the text. (3) Sample cutoffs. Choudhary et al.’s sample ended onNovember 18, 2005, while ours included observations through the end of 2005. To examine whether this dif-ference caused the difference in results, we deleted observations post-November 18. Our results for the an-nouncement window are still positive, but are no longer statistically significant. (4) Window lengths. We ex-amined (�2,2) window surrounding the announcement date and found positive and significant CAR based onour sample and positive and insignificant CAR based on the observations using the November 18, 2005, cutoff.In summary, in the vast majority of our analyses we found significantly positive CAR, while in a small minorityof analyses we found insignificant CAR, which indicate that overall markets responded positively to announce-ments of accelerations.

16 Additionally, we rerun our regressions after excluding 28 observations with earnings announcements withinthe three-day acceleration approval window, 32 within the three-day announcement window, and 96 within theextended window. We find our results are unaffected by exclusion of these observations.



options in advance of the mandatory adoption date of SFAS No. 123(R) to avoid recogniz-ing the expense that would be associated with their already granted but not yet vestedoptions post-adoption. For these firms the amounts avoided were material, averaging $11.3million pretax and $8.4 million after tax. Better illustrating the importance of the acceler-ation, the cost avoided represented 42 percent of prior year income.

We find that on average investors reacted positively to the disclosure of the acceleration,with the average abnormal return being 0.524 percent for the three-day window beginningone day before and ending one day after the announcement. Cross-sectionally analyzingthe choice to accelerate, we find that the grant date value of those options, which representsour estimate of the expense avoided via the acceleration, is a strong positive influence onthe decision to accelerate. In contrast, the intrinsic value of unvested options, which rep-resents the amount the firm would have to recognize in the period of acceleration, firmprofitability in the acceleration year, and firm size (that is, political visibility) are negativeinfluences. We interpret these results to indicate that managers considered the costs, as wellas the benefits, in deciding whether to accelerate. The expense avoided, which is proxiedfor by the grant date value of the unvested options, represents the benefit, while the intrinsicvalue of those options, the amount that would have to be expensed in the period of accel-eration, represents one of the costs. Cross-sectionally analyzing the abnormal returns to theacceleration we find a strong positive association for the amount of expense avoided, aswell as for the acceleration only being for options that are out of the money. Our interpre-tation of these findings is that investors reacted positively to accelerations that had greaterbenefits in terms of expense savings, which may reduce future debt servicing costs andcost of capital, and lower costs with respect to employee retention, as the options were outof the money and could not be exercised immediately. Overall we conclude that whileaccelerated vesting can be considered a form of earnings management, it appears to beearnings management that benefits equity investors, as evidenced by the positive abnormalreturns associated with the announcement of the acceleration and the fact that abnormalreturns are positively associated with the expense avoided via acceleration.

Our findings contribute to the line of research showing how accounting considerationsaffect real transactions. In addition to being of interest to academics, this should interestpractitioners and accounting standard setters, with the latter needing to anticipate the re-action to their promulgations.

APPENDIXEXAMPLE OF ACCELERATION ANNOUNCEMENT BY ALCOA,

CONTAINED IN ITS 8-K FILED NOVEMBER 16, 2005(Acceleration approval date November 11, 2005;

actual accelerated vesting date December 31, 2005.)On November 11, 2005, the Compensation and Benefits Committee (the ‘‘Committee’’)

of the Board of Directors of Alcoa Inc. (‘‘Alcoa’’), after review by the Audit Committeeand the full Board of Directors, approved accelerating the vesting to December 31, 2005,of 11 million unvested stock options granted to employees in 2004, and on January 13,2005, including such options held by the executive officers named in Alcoa’s proxy state-ment dated February 22, 2005. The options to purchase Alcoa common stock were grantedunder the 2004 Alcoa Stock Incentive Plan (the ‘‘Plan’’) and a predecessor plan (the AlcoaStock Incentive Plan). The 2004 and 2005 accelerated options have weighted average ex-ercise prices of $35.60 and $29.54, respectively, and in the aggregate represent approxi-mately 12 percent of Alcoa’s total outstanding options. Under the original vesting schedule,



the 2004 and 2005 stock options vest 1/3 on the first anniversary of the grant date, 1/3 onthe second anniversary of the grant date, and 1/3 on the third anniversary of the grant date.

The decision to accelerate the vesting of the 2004 and 2005 options was made primarilyto avoid recognizing the related compensation cost in future financial statements upon theadoption of Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004)Share-Based Payment, which Alcoa will adopt on January 1, 2006, when it is required.Alcoa expects the accelerated vesting of the 2004 and 2005 stock options to reduce its pre-tax stock option compensation expense in 2006 by approximately $35 million and in 2007by approximately $10 million. The company believes that because the options to be accel-erated have exercise prices in excess of the current market price of the common stock, theoptions have limited economic value at this time and recognition of this expense couldoverstate the compensation value.

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