The Impact of Financial and Tax Reporting Incentives on Option Grants to Canadian CEOs

Abstract

This study explores the effects of financial and tax reporting incentives on options granted to chief executive officers in Canada. Extant studies with a similar objective (Yermack 1995;Matsunaga 1995) explore predominantly nonqualified U.S. option grants that are deductible to the extent that the options are in the money at the time of exercise. In contrast, Canadian firms do not get a tax deduction for their stock option grants at any time. In both countries, no expense is recorded for financial reporting purposes. As a result, the financial reporting and tax reporting trade-off is more pronounced in the Canadian setting of this study compared with the U.S. setting.We measure option granting behavior as the ratio of the Black-Scholes value of stock option grants to the sum of cash compensation and the value of stock option grants. Using a sample of 806 firm-year observations during the period 1993-95, we find that observed option grants are significantly correlated with proxies for short-run financial reporting incentives. We also find evidence that option granting behavior is correlated with proxies for tax incentives. Keywords Stock options; Taxation; Financial reporting; Hypothesis testing CondenséLe recours aux options d'achat d'actions dans le régime de rémunération des cadres peut augmenter le bénéfice déclaré dans le contexte de l'information financière puisque la charge au titre des salaires afférente aux options dans l'état des résultats est habituellement nulle. Il se peut donc que les sociétés plus sensibles au bénéfice déclaré (c'est-à-dire celles pour qui les coûts de l'information financière sont plus élevés) soient davantage susceptibles d'octroyer à leurs cadres des options d'achat d'actions, de manière à éviter la constatation Plus précisément, le contexte canadien est fort différent du contexte des États-Unis sur lequel se sont penchés Yermack (1995) et Matsunaga (1995. Ces derniers testent dans leurs études les données des États-Unis relatives à l'octroi d'options majoritairement sans restriction dont l'avantage connexe peut être déduit par la société au moment de la levée. Les auteurs de la présente étude, au contraire, examinent les options octroyées au Canada pour lesquelles aucune déduction fiscale n'est permise au moment de la levée. Le recours aux options exige donc des sociétés canadiennes qu'elles parviennent à un compromis entre les avantages de l'information financière et les coûts fiscaux, tandis que le recours aux options sans restriction aux États-Unis offre le meilleur des deux mondes (la déductibilité fiscale et aucune charge dans l'état des résultats). En conséquence, l'élément fiscal dissuasif que comporte l'octroi d'options devrait être plus accentué dans la présente étude que dans celle de Yermack (1995) ou de Matsunaga (1995). Le principal apport des auteurs est ici de documenter les conséquences de l'absence de déduction fiscale sur l'octroi par les sociétés d'options d'achat d'actions aux cadres. Les auteurs recueillent également d'autres faits démontrant l'inci...

The Evolution of High Incomes in Canada, 1920-2000

“…If lower income anglophones left disproportionately, then we would expect the top shares of anglophones to increase mechanically through a compositional effect. treatment (Klassen and Mawani, 2000). 30 In contrast to the United States, profits from stock-option exercises can be separated out from wages and salaries on Canadian income tax returns.…”

Employees compensation: Do taxes play any role? Evidence from the compensation-taxation literature

“…Studies aimed at empirically documenting the relationship between corporate use of stock-based compensation and corporate failure will interestingly confirm or disconfirm Johnson"s anxiety in this regard and shows if his contention is appropriately placed. This is important in that Klassen and Mawani (2000) provide statistics that stock options are increasingly becoming a significant part of executives" compensation package both in Canada and the U.S. Yermack (1995) earlier raised concerns as to the high probability that stock options are being abused by managers who engage in "managerial self-interest, or rent-seeking behavior by senior management." 7 In what seems like contemporaneous study, Mawani…”

“…(2003) portrays stock options in a more positive light claiming, for example, that instead of stock options widening the incentive asymmetry gap between managers and the shareholders, they can actually be used to align "the employees" interests and long-term incentives with those of shareholders" thus potentially reducing agency costs. Klassen and Mawani (2000), in their study of option grants to Canadian CEOs, examine the relationships and interrelationships between financial reporting and tax reporting incentives vis-à-vis stockbased compensation. 8 They find that there is a significant relationship between their "proxies for short-run financial reporting incentives and the observed option grants."…”

Backdating of CEO Stock Option Grants and Timing of Earnings Disclosures

“…Chauvin and Shenoy (2001) find a significant abnormal decrease in stock prices during the 10-day period immediately preceding the option grant date and attribute it to the timing of information disclosure. The notion that management manipulates investors' expectations via good-timing of disclosure to increase managerial compensation has been extended to other settings such as option repricing (Callaghan, Saly, and Subramaniam 2004) and option exercises (Huddart and Lang 2003; Bartov and Mohanram 2004) as well as to other markets-e.g., Canadian firms (Klassen and Mawani 2000).…”