_________________________________________________________________
E M P L O Y E E B E N E F I T S , C O M P E N S A T I O N
& P E N S I O N L A W
Vol. 5, No. 19: October 7, 2004
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Publisher: LSN Employment, Labor, Compensation & Pension Journals
a division of
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Editor: PAMELA PERUN
Urban Institute
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Copyright: SSEP, Inc. 2004. All rights reserved.
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Topic of This Issue:
Equity Issues
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T A B L E of C O N T E N T S
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NEW and FORTHCOMING ARTICLES
"Expensing Isn't the Only Option: Alternatives to the FASB's
Stock Option Expensing Proposal"
Journal of Corporation Law, Vol. 30, 2005
BEN TEMPLIN
Thomas Jefferson School of Law
WORKING PAPERS
"Do a Firm's Equity Returns Reflect the Risk of Its Pension
Plan?"
LI JIN
Harvard University
Finance Unit
ROBERT C. MERTON
Harvard University
Finance Unit
National Bureau of Economic Research (NBER)
ZVI BODIE
Boston University
Department of Finance & Economics
"Bulls, Bears, and Retirement Behavior"
COURTNEY COILE
Wellesley College
Department of Economics
National Bureau of Economic Research (NBER)
PHILLIP B. LEVINE
Wellesley College
National Bureau of Economic Research (NBER)
"Stealth Compensation Via Retirement Benefits"
LUCIAN ARYE BEBCHUK
Harvard Law School
National Bureau of Economic Research (NBER)
JESSE M. FRIED
University of California, Berkeley - School of Law
"Expensing Executive Stock Options: Sorting Out the Issues"
DON M. CHANCE
Louisiana State University, Baton Rouge
"Employees' Investment Decisions about Company Stock"
JAMES J. CHOI
Harvard University
Department of Economics
DAVID I. LAIBSON
Harvard University
Department of Economics
National Bureau of Economic Research (NBER)
BRIGITTE MADRIAN
University of Pennsylvania
The Wharton School
National Bureau of Economic Research (NBER)
ANDREW METRICK
University of Pennsylvania - The Wharton School
National Bureau of Economic Research (NBER)
"Company Stock, Market Rationality, and Legal Reform"
SHLOMO BENARTZI
University of California at Los Angeles
RICHARD H. THALER
University of Chicago
Graduate School of Business
National Bureau of Economic Research (NBER)
STEPHEN P. UTKUS
Vanguard Center for Retirement Research
CASS R. SUNSTEIN
University of Chicago Law School
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N E W and F O R T H C O M I N G Articles
_________________________________________________________________
"Expensing Isn't the Only Option: Alternatives to the FASB's
Stock Option Expensing Proposal"
Journal of Corporation Law, Vol. 30, 2005
BY: BEN TEMPLIN
Thomas Jefferson School of Law
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=573162
Paper ID: TJSL Public Law Research Paper No. 04-12
Contact: BEN TEMPLIN
Email: Mailto:btemplin@tjsl.edu
Postal: Thomas Jefferson School of Law
2121 San Diego Avenue
San Diego, CA 92110 UNITED STATES
Phone: 619-297-9700
Fax: 619-296-4284
ABSTRACT:
This working paper reviews the arguments for and against the
Financial Accounting Standard Board's (FASB) proposal to require
that corporations expense options. It identifies two major goals
of the proposed rule - 1) clarity in financial statements and 2)
a reduction of corporate fraud by removing the incentive of
options. To address these two goals, I adopt a framework of
Information Reforms v. Rules of the Game Reforms. The article
starts with a history of FASB Statement No. 123 Accounting for
Stock-based Compensation and also analyzes the Congressional
legislation that attempts to block the measure, the Stock Option
Accounting Reform Act. I review the opinions of leading
economists on the accuracy of the option valuation schemes
advocated by the FASB and conclude that the models are too
easily manipulated to advance the FASB goals of clarity in
accounting. I conclude that neither the FASB proposed rule nor
the Congressional legislation advances the goal of clarity in
financial statements.
The article suggests alternative measures that would better
serve the interests of investors. I argue that a more accurate
solution to the expense problem would be to adopt the IRS method
for valuing stock options - intrinsic value at date of exercise.
This accounting method tracks the cash flow out of the
corporation since it reflects either an actual repurchase of
shares issued by the company or a lost opportunity cost. In
addition, I propose that corporations be required to only use
fully diluted, in-the-money capitalization when computing EPS.
This measure would address the FASB's concerns that the employee
is given a valuable equity instrument at date of grant without
there being a reflection in the company's financials.
Finally, I review the literature that analyzes the impact of
the FASB proposal on companies and the economy as a whole. The
data shows that the FASB measure will not result in a reduction
of corporate accounting fraud and the measure will result in a
loss of productivity among American firms that use options to
incentivize workers. I argue that the FASB proposed rule should
be considered independent of considerations such as a reduction
in fraud. The measure should solely be considered as an
Information Reform, which by its nature is meant to improve the
clarity of information rather than modify behavior. Modifying
the behavior of executives who commit fraud or boards of
directors who make large option grants requires more fundamental
Rules of the Game Reforms rather than Information Reforms.
Typical Rules of the Game Reforms would shift the power from
management and the Board of Directors to shareholders and might
include restrictions on the sale of executive stock so as to
better align the interests of shareholders and employees.
JEL Classification: M41, M44, G38, J33
______________________________
W O R K I N G P A P E R Abstracts
_________________________________________________________________
"Do a Firm's Equity Returns Reflect the Risk of Its Pension
Plan?"
BY: LI JIN
Harvard University
Finance Unit
ROBERT C. MERTON
Harvard University
Finance Unit
National Bureau of Economic Research (NBER)
ZVI BODIE
Boston University
Department of Finance & Economics
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=579797
Paper ID: NBER Working Paper No. W10650
Date: July 2004
Contact: ROBERT C. MERTON
Email: Mailto:rmerton@hbs.edu
Postal: Harvard University
Finance Unit
Boston, MA 02163 UNITED STATES
Phone: 617-495-6678
Fax: 617-496-7357
Co-Auth: LI JIN
Email: Mailto:ljin@hbs.edu
Postal: Harvard University
Finance Unit
Boston, MA 02163 UNITED STATES
Co-Auth: ZVI BODIE
Email: Mailto:zbodie@bu.edu
Postal: Boston University
Department of Finance & Economics
595 Commonwealth Avenue
Boston, MA 02215 UNITED STATES
Paper Requests:
Full-Text downloads are free to persons at institutions that
subscribe to the NBER Working Paper Series. Other persons can
download the paper from SSRN for a $5 charge.
ABSTRACT:
This paper examines the empirical question of whether systematic
equity risk of U.S. firms as measured by beta from the Capital
Asset Pricing Model reflects the risk of their pension plans.
There are a number of reasons to suspect that it might not.
Chief among them is the opaque set of accounting rules used to
report pension assets, liabilities, and expenses. Pension plan
assets and liabilities are off-balance sheet, and are often
viewed as segregated from the rest of the firm, with its own
trustees. Pension accounting rules are complicated. Furthermore,
the role of Pension Benefit Guaranty Corporation further clouds
the real relation between pension plan risk and firm equity
risk. The empirical findings in this paper are consistent with
the hypothesis that equity risk does reflect the risk of the
firm's pension plan despite arcane accounting rules for
pensions. This finding is consistent with informational
efficiency of the capital markets. It also has implications for
corporate finance practice in the determination of the cost of
capital for capital budgeting. Standard procedure uses
de-leveraged equity return betas to infer the cost of capital
for operating assets. But the de-leveraged betas are not
adjusted for the risk of the pension assets and liabilities.
Failure to make this adjustment will typically bias upwards
estimates of the discount rate for capital budgeting. The
magnitude of the bias is shown here to be large for a number of
well-known U.S. companies. This bias can result in positive
net-present-value projects being rejected.
JEL Classification: G14, G23, G31
______________________________
"Bulls, Bears, and Retirement Behavior"
BY: COURTNEY COILE
Wellesley College
Department of Economics
National Bureau of Economic Research (NBER)
PHILLIP B. LEVINE
Wellesley College
National Bureau of Economic Research (NBER)
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=593461
Paper ID: NBER Working Paper No. W10779
Date: September 2004
Contact: COURTNEY COILE
Email: Mailto:CCOILE@WELLESLEY.EDU
Postal: Wellesley College
Department of Economics
106 Central Street
Wellesley, MA 02181 UNITED STATES
Phone: 781-283-2408
Fax: 781-283-2177
Co-Auth: PHILLIP B. LEVINE
Email: Mailto:PLEVINE@WELLESLEY.EDU
Postal: Wellesley College
106 Central Street
Wellesley, MA 02181 UNITED STATES
Paper Requests:
Full-Text downloads are free to persons at institutions that
subscribe to the NBER Working Paper Series. Other persons can
download the paper from SSRN for a $5 charge.
ABSTRACT:
The historic boom and bust in the stock market over the past
decade had the potential to significantly alter the retirement
behavior of older workers. Previous research examining the
impact of wealth shocks on labor supply supports the
plausibility of this hypothesis. In this paper, we examine the
relationship between stock market performance and retirement
behavior using the Health and Retirement Study (HRS), Current
Population Survey (CPS), and Survey of Consumer Finances (SCF).
We first present a descriptive analysis of the wealth holdings
of older households and simulate the labor supply response among
stockholders necessary to generate observed patterns in
retirement. We show that few households have substantial stock
holdings and that they would have to be extremely responsive to
market fluctuations to explain observed labor force patterns. We
then exploit the unique pattern of boom and bust along with
variation in stock exposure to generate a double
quasi-experiment, comparing the retirement and labor force
re-entry patterns over time of those more and less exposed to
the market. Any difference in behavior that emerged during the
boom should have reversed itself during the bust. We find no
evidence that changes in the stock market drive aggregate trends
in labor supply.
JEL Classification: J14, J26
______________________________
"Stealth Compensation Via Retirement Benefits"
BY: LUCIAN ARYE BEBCHUK
Harvard Law School
National Bureau of Economic Research (NBER)
JESSE M. FRIED
University of California, Berkeley - School of Law
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=590730
Paper ID: NBER Working Paper No. W10742
Date: September 2004
Contact: LUCIAN ARYE BEBCHUK
Email: Mailto:bebchuk@law.harvard.edu
Postal: Harvard Law School
1563 Massachusetts Avenue
Cambridge, MA 02138 UNITED STATES
Phone: 617-495-3138
Fax: 617-496-3119
Co-Auth: JESSE M. FRIED
Email: Mailto:FRIEDJ@MAIL.LAW.BERKELEY.EDU
Postal: University of California, Berkeley - School of Law
Boalt Hall
Berkeley, CA 94720-7200 UNITED STATES
Paper Requests:
Full-Text downloads are free to persons at institutions that
subscribe to the NBER Working Paper Series. Other persons can
download the paper from SSRN for a $5 charge.
ABSTRACT:
This paper analyzes an important form of 'stealth compensation'
provided to managers of public companies. We show how boards
have been able to camouflage large amount of executive
compensation through the use of retirement benefits and
payments. Our study highlights the significant role that
camouflage and stealth compensation play in the design of
compensation arrangements. Our study also highlights the
significance of whether information about compensation
arrangements is not merely publicly available but also
communicated in a way that is transparent and accessible to
outsiders.
JEL Classification: D23, G32, G34 G38, J33, J44, K22, M14
______________________________
"Expensing Executive Stock Options: Sorting Out the Issues"
BY: DON M. CHANCE
Louisiana State University, Baton Rouge
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=590324
Date: September 2004
Contact: DON M. CHANCE
Email: Mailto:dchance@lsu.edu
Postal: Louisiana State University, Baton Rouge
Baton Rouge, LA 70803 UNITED STATES
Phone: 225-578-0372
Fax: 225-578-6366
ABSTRACT:
This paper examines the issues and controversies over the
question of whether executive stock options should be expensed
and, if so, how option values should be determined. It
identifies and clarifies the key questions and surveys and
synthesizes the academic and trade literature. Illustrations and
analyses of valuation models are provided. The paper identifies
several key issues that have received little attention, such as
whether the value to the executive is the cost to the company,
how the effects of vesting and forfeiture should be incorporated
while maintaining consistency with sound valuation theory, and
whether these options should be marked to market. The paper also
identifies two areas that have received almost no attention in
either the practitioner or academic literature. One is the
effect of taxes on the values of these options. The other is the
impact, if any, of the influence an executive presumably has on
the payoff of the option on the executive's willingness to hold
an undiversified portfolio and what effect this factor has on
the value of the option.
JEL Classification: G34, G13, J33, M41, H24, M52
______________________________
"Employees' Investment Decisions about Company Stock"
BY: JAMES J. CHOI
Harvard University
Department of Economics
DAVID I. LAIBSON
Harvard University
Department of Economics
National Bureau of Economic Research (NBER)
BRIGITTE MADRIAN
University of Pennsylvania
The Wharton School
National Bureau of Economic Research (NBER)
ANDREW METRICK
University of Pennsylvania - The Wharton School
National Bureau of Economic Research (NBER)
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=562513
Paper ID: Rodney L. White Center for Financial Research Working
Paper No. 10-04
Date: July 2003
Contact: ANDREW METRICK
Email: Mailto:metrick@wharton.upenn.edu
Postal: University of Pennsylvania - The Wharton School
The Wharton School
3620 Locust Walk
Philadelphia, PA 19104 UNITED STATES
Phone: (215) 898-4260
Fax: (215) 898-6200
Co-Auth: JAMES J. CHOI
Email: Mailto:JAMES_CHOI@POST.HARVARD.EDU
Postal: Harvard University
Department of Economics
Room M-14
Littauer Center
Cambridge, MA 02138 UNITED STATES
Co-Auth: DAVID I. LAIBSON
Email: Mailto:dlaibson@harvard.edu
Postal: Harvard University
Department of Economics
Room M-14
Littauer Center
Cambridge, MA 02138 UNITED STATES
Co-Auth: BRIGITTE MADRIAN
Email: Mailto:bmadrian@wharton.upenn.edu
Postal: University of Pennsylvania
The Wharton School
3641 Locust Walk
Philadelphia, PA 19104-6365 UNITED STATES
Paper Requests:
Contact Elaine Thomas, Rodney L. White Center for Financial
Research, 3254 Steinberg Hall-Dietrich Hall, The Wharton School,
University of Pennsylvania, Philadelphia, PA 19104-6367. Phone:
(215)898-7616. Fax: (215)573-8084. Requestors who are not
subscribers to the Center's working paper series, not affiliated
with an academic institution, or members of the Center will be
charged $25 per paper. Mailto:rlwctr@finance.wharton.upenn.edu
ABSTRACT:
We study the relationship between past returns on a company's
stock and the level of investment in that stock by the
participants in that company's 410(k) plan. Using data on the
94,191 plan participants, we analyze several different decision
points: the initial fraction of saving allocated to a company
stock, the changes in this fraction, and the reallocations of
portfolio holdings across different asset classes. Like Benartzi
(2001), we find that high past returns on company stock induce
participants to allocate more of their contributions to company
stock. We also find, however, that high returns on company stock
have the opposite effect on reallocations of portfolio holdings,
with high returns leading to shifts away from company stock and
onto other forms of equity. Overall, for company and stock
decisions, participants in our sample appear to be momentum
investors when making contribution decisions and contrarian
investors when making trading decisions.
______________________________
"Company Stock, Market Rationality, and Legal Reform"
BY: SHLOMO BENARTZI
University of California at Los Angeles
RICHARD H. THALER
University of Chicago
Graduate School of Business
National Bureau of Economic Research (NBER)
STEPHEN P. UTKUS
Vanguard Center for Retirement Research
CASS R. SUNSTEIN
University of Chicago Law School
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=573504
Paper ID: U Chicago Law & Economics, Olin Working Paper No. 218
Date: July 2004
Contact: CASS R. SUNSTEIN
Email: Mailto:CSUNSTEI@MIDWAY.UCHICAGO.EDU
Postal: University of Chicago Law School
1111 E. 60th St.
Chicago, IL 60637 UNITED STATES
Phone: 773-702-9498
Fax: 773-702-0730
Co-Auth: SHLOMO BENARTZI
Email: Mailto:sbenartz@ucla.edu
Postal: University of California at Los Angeles
D410 Anderson Complex
Los Angeles, CA 90095-1481 UNITED STATES
Co-Auth: RICHARD H. THALER
Email: Mailto:richard.thaler@gsb.uchicago.edu
Postal: University of Chicago
Graduate School of Business
1101 East 58th Street
Chicago, IL 60637 UNITED STATES
Co-Auth: STEPHEN P. UTKUS
Email: Mailto:steve_utkus@vanguard.com
Postal: Vanguard Center for Retirement Research
100 Vanguard Boulevard, J24
Malvern, PA 19355 UNITED STATES
ABSTRACT:
Some eleven million 401(k) plan participants take a concentrated
equity position in their retirement savings account, investing
more than 20% of the balance in their employer's common stock.
Yet investing in the stock of one's employer is a risky
investment on two counts: single securities are riskier than
diversified portfolios (such as mutual funds), and the
employee's human capital is typically positively correlated with
the performance of the company. In the worst-case scenario,
illustrated by the Enron bankruptcy, workers can lose their jobs
and much of their retirement wealth simultaneously. For workers
who expect to work for the company for many years, a dollar of
company stock can be valued at less than 50 cents to the worker
after accounting for the risks. But employees still invest
voluntarily in their employers' stock, and many employers insist
on making matching contributions in stock, despite the fact that
a dollar of investment or contribution may be worth only 50
cents on the dollar. How can competitive labor markets sustain a
situation in which employers and employees make such a
fundamental miscalculation? We provide evidence that employees
underestimate the risk of owning company stock, while employers
overestimate the benefits associated with employee stock
ownership relative to its costs. This evidence provides strong
reasons to consider legal reforms in this domain. We make
suggestions that would increase employees' freedom of choice and
improve their welfare, but without imposing significant costs on
well-meaning but ill-informed employers.