SFAS 123 Stock-Based Compensation Expense and Equity Market Values

This study investigates the relation between share price and stock-based compensation expense that is disclosed but not recognized under SFAS 123, after controlling for net income, equity book value, and expected earnings growth. Our instrumental variables approach controls for the mechanical relation between share price and option values. We find that investors view SFAS 123 expense as an expense of the firm, and as sufficiently reliable to be reflected in their valuation assessments. Findings based on annual returns indicate SFAS 123 expense reflects on a timely basis changes in investor-perceived costs associated with stock-based compensation.