Does Option-Based Compensation Affect Payout Policy? Evidence from FAS123R

Abstract

Does option-based compensation have a causal influence on payout policy? To address this question we examine the adoption of mandatory expensing of stock options (via accounting standard FAS123R), a plausible exogenous shock to the use of option-based compensation. As FAS123R applies to all firms, our identification strategy exploits the fact that the reduction in option-based compensation in response to the accounting standard varies with the firm-specific expected accounting impact, as measured by the option expense disclosed in the footnotes prior to FAS123R. Using a difference-in-difference research design, across a battery of tests we do not find that (accounting-driven) reductions in option-based pay cause dividends to increase, repurchases to decrease or the payout composition to change. Our results contrast with the widely held belief that option-based pay has a significant causal influence on payout policy and cast doubts on its role in the shift from dividends to repurchases in recent decades.

Keywords: dividends, repurchases, executive stock options, FAS123R, payout policy

JEL Classification: G35, M41, M48, M52