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A censored quantile regression analysis of employee stock options substitution for debt and the impact of SFAS 123R

Hui Di (Department of Accounting and Finance, Doermer School of Business, Indiana University – Purdue University Fort Wayne, Fort Wayne, Indiana, USA)
Steven A. Hanke (Department of Accounting and Finance, Doermer School of Business, Indiana University – Purdue University Fort Wayne, Fort Wayne, Indiana, USA)
Wei‐Chih Chiang (School of Business Administration, University of Houston – Victoria, Victoria, Texas, USA)

Managerial Finance

ISSN: 0307-4358

Article publication date: 13 January 2012

Abstract

Purpose

This paper aims to examine whether the substitution of employee stock options (ESOs) for debt occurs for firms with different tax status classifications throughout the conditional distribution of interest expense before and after the implementation of Statement of Financial Accounting Standard 123R (SFAS 123R).

Design/methodology/approach

This study uses Censored Quantile Regression (CQR) to assess whether the substitution effect is dependent on firms' position in the conditional distribution of interest expense. Our sample firms are categorized into two groups: one group (tax‐sensitive) that is sensitive to additional deductions due to a moderate income level and the other group (tax‐insatiable) that is not sensitive because of very high income level.

Findings

The substitution effect is not present for firms with below medium level of interest expense. Only tax‐sensitive firms substitute at medium levels of interest expense while both tax‐sensitive and tax‐insatiable firms substitute at high levels of interest expense. Tax‐insatiable firms with very high levels of interest expense also substitute; however, tax‐sensitive firms with very high levels of interest expense only substitute after SFAS 123R required firms to report ESO expense in financial statements. We attribute the substitution patterns revealed by the CQR analysis to a positive relationship between interest expense and cost of debt.

Originality/value

To the authors' knowledge, this is the first paper to analyze firms' tax status classification impact on the substitution of ESO expense for interest expense across different levels of interest expense. Our application of CQR should benefit researchers who are interested in examining explanatory variables' impact at various points in the conditional distribution of the dependent variable. This study also refines the conjecture that ESOs are substitutes for debt by demonstrating that such relationship is dependent on the level of interest expense and tax status. Furthermore, the finding of firms substituting ESOs for debt provides accounting standard setters a reason to begin requiring firms to re‐measure the value of ESOs after the grant date until the exercise date.

Keywords

Citation

Di, H., Hanke, S.A. and Chiang, W. (2012), "A censored quantile regression analysis of employee stock options substitution for debt and the impact of SFAS 123R", Managerial Finance, Vol. 38 No. 2, pp. 165-187. https://doi.org/10.1108/03074351211193712

Publisher

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Emerald Group Publishing Limited

Copyright © 2012, Emerald Group Publishing Limited