Executive Stock Options & Earnings Restatement

When a company divides its ownership into shares of stock that various investors can purchase, this is called a corporation. Since the investors who own corporations usually do not engage heavily in company operations, they hire executives to oversee the day-to-day matters of business. These executives oversee the issuance of earnings statements to show company viability, and one way in which they receive pay is through stock options.

Stock Options

While most employees receive pay strictly through a set salary, executives and some other employees of corporations receive pay in part through stock options. A stock option is an agreement that a corporation makes with a party to sell company stock at a certain price at a certain point in time, but only if the buyer decides to buy when that time comes. Stock options work as compensation for corporate employees because it allows them to purchase a marketable asset for less than the market price.

Earnings Restatements

Corporations issue statements regarding their earnings on a regular basis. However, due to the complexity of corporate accounting, accountants may realize after the fact that a recently issued earnings statement was flawed. When this occurs, they must issue an earnings restatement for the given period. Earnings restatements tend to cause investors to see corporations in a negative light, as they stand as evidence that the corporation is prone to accounting mistakes.

Conflict of Interest

The idea of awarding stock options to executives is to give them incentive to run the company in a profitable, efficient and stable manner. Stock options may also be more advantageous when it comes to taxation than a cash bonus. However, in some cases, executives may feel tempted to overstate earnings for the sake of increasing their compensation through stock options. Such overstatements frequently necessitate the issuance of an earnings restatement.

Restatement Results

Since the issuance of earnings restatements reflects poorly on corporate management, the board of directors of corporations may respond to such restatements by renegotiating employee compensation through stock options. Statistics show that corporations that experience earnings restatements do actually show a high tendency of doing so, according to Qiang Cheng and David B. Farber.

References

• "The Accounting Review"; Earnings Restatements, Changes in CEO Compensation, and Firm Performance; Qiang Cheng; 2008
• "The Accounting Review"; The Reputational Penalty for Aggressive Accounting; Hemang Desai; 2006
• International Conference on Financial Management and Economics; Earnings Restatement and Stock Compensation; Hsueh-En Hsu; 2011