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Journal of Economic Perspectives: Vol. 19 No. 4 (Fall 2005)

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Accounting for Stock Options

Article Citation

Bulow, Jeremy, and John B. Shoven. 2005. "Accounting for Stock Options." Journal of Economic Perspectives, 19(4): 115-134.

DOI: 10.1257/089533005775196714

Abstract

As public companies begin their new fiscal years, they are implementing a new and controversial Financial Accounting Standards Board (FASB, 2004) proposal for expensing stock options. Applied to 2003 and 2004, this rule would have slashed reported earnings of the Standard & Poor's 500 by 8.6 and 7.4 percent; the effect in the bubble years would have been more than twice as large. We describe the history of how these options have been expensed for financial statement purposes. We assess the new FASB approach and find that it is deeply flawed. The main purpose of the paper is to describe an alternative options expense valuation method, the Bulow-Shoven approach, that addresses these problems. Our approach is simpler than the new FASB methodology, less prone to earnings manipulation and more consistent with the way the rest of compensation is treated in financial statements.

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Authors

Bulow, Jeremy
Shoven, John B.

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