Accounting for employee stock options: What can we learn from the market's perceptions?

The scope of this is paper is to provide new empirical evidence on the value relevance of employee stock options (ESOs) in Europe. We show, empirically, that the market participants when pricing a firm’s equity place approximately the same valuation weights on the ESO deferred compensation expense (the so called “ESO asset”) and the compensation option liability (the so called “ESO liability”). Our empirical findings support the theoretical work of Ohlson and Penman (2005) who suggest that the deferred compensation expense be treated as a contra-liability. The second contribution of our work rests on the nature of the ESO expense. We show that the distinction between persistent and non-persistent ESO expenses is of critical importance for the market participants. Accordingly, an improved accounting disclosure should assist the investors in assessing the long term goals of the ESO plans at the firm level.