Accounting for the Tax Benefits of Employee Stock Options and Implications for Research

Abstract

This paper explains firm disclosures of the tax benefits of employee stock options and discusses the implications of this disclosure for academic research studies and financial statement users. We do this in order to show that there are important implications for empirical research studies and inferences regarding tax burdens. The effects of this accounting have not often been taken into account in empirical research yet it may impact the inferences made from the studies. We find that firm disclosures are not always clear as to the amount of the corporate tax benefits from the exercise of stock options. In addition, in many cases, firms' reported effective tax rates are overstated as are estimates of marginal tax rates and tax burdens using financial statement disclosures. This study is important because it explains the accounting for the tax benefits of stock options, describes the problems this accounting may cause in empirical studies and for financial statement users, and provides some suggestions on adjusting for this accounting to more correctly estimate tax rates and burdens.

Keywords: Employee stock options, Tax benefits, Effective tax rates, Marginal tax rate

JEL Classification: M41, H25, G39