The Valuation Implications of Employee Stock Option Accounting for Computer Software Firms

In this study we compare the ability of alternative accounting methods for employee stock options (ESOs) to reflect firm value using the Ohlson [1995, 1999] and Feltham-Ohlson [1999] valuation models for a sample of 85 computer software firms. The three methods we compare are APB 25, ESO expense recognition based on SFAS 123 disclosures, and asset recognition at grant date based on the Exposure Draft: Accounting for Stock-Based Compensation. We estimate abnormal earnings forecasting and valuation equations for each accounting method. Findings suggest that the method of recognition of an asset at grant date best reflects the market?s valuation of ESO transactions. A robustness test indicates the asset may have a useful life longer than the option vesting period. An additional robustness test indicates that findings are not the result of endogeneity bias