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The impact of stock options compensation on earnings and probability of bankruptcy.

INTRODUCTION

As the debate around excessive corporate executive compensation heats up in the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area.  in the era of Troubled Asset Relief Program (TARP) (1), the debate on the efficacy of stock options compensation is not yet settled. The restrictions on executive salaries and bonuses by firms that benefitted from TARP is likely to spread to comparable companies in the US. To avoid high political costs while at the same time keeping the option of providing incentives for managers to optimize optimize - optimisation  firm value, Board of Directors may opt to increase equity related compensations such as stock options.

The objective of this study is to investigate the impact of stock options compensation on earnings and probability of bankruptcy bankruptcy, in law, settlement of the liabilities of a person or organization wholly or partially unable to meet financial obligations. The purposes are to distribute, through a court-appointed receiver, the bankrupt's assets equitably among creditors and, in most  of the firm. Hanlon Hanlon is a surname, and may refer to
  • Darren Hanlon, Australian folk musician
  • Glen Hanlon, Canadian ice hockey player and coach
  • John Hanlon, New Zealand singer-songwriter
  • Ned Hanlon, American baseball manager
  • Richie Hanlon, fictional character from
, Rajgopal and Shevlin 2003 (HRS hrs abbr (= hours) → h

hrs abbr (= hours) → Std. 
) document the incentive alignment hypothesis of executive stock options, but the authors use reported operating performance as the dependent measure. We argue that the positive contributions of executive stock options to reported earnings documented in that study could have been exaggerated if one considers the real potentials of earnings management, and so corporate boards and compensation committees should exercise caution in the interpretations of HRS finding. Therefore, in part, we examine executive stock options contributions to other measure of earnings after controlling for earnings management using nondiscretionary earnings as a dependent measure. While we find a positive contribution consistent with incentive alignment, the magnitude of such contribution is substantially lower. This suggests that nondiscretionary earnings will be a better measure of corporate performance as a guide for executive compensation decisions.

Prior studies have examined empirically and analytically an·a·lyt·ic   or an·a·lyt·i·cal
adj.
1. Of or relating to analysis or analytics.

2. Dividing into elemental parts or basic principles.

3.
 a variety of issues ranging from the role of taxes in the decision to grant options (e.g., Klassen Klassen is the surname of:
  • Ben Klassen (1918-1993), American politician
  • Cindy Klassen (born 1979), Canadian skater
  • Danny Klassen (born 1975), American-Canadian baseball player
 and Mawani, 2000), the choice between incentive stock options and nonqualified options (e.g., Austin Austin.

1 City (1990 pop. 21,907), seat of Mower co., SE Minn., on the Cedar River, near the Iowa line; inc. 1868. The commercial and industrial center of a rich farm region, it is noted as home to the Hormel meatpacking company, whose Spam Town museum
 et al, 1998), the tax deductibility of stock options (e.g., Balsam balsam (bôl`səm), fragrant resin obtained from various trees. The true balsams are semisolid and insoluble in water, but they are soluble in alcohol and partly so in hydrocarbons.  et al., 1996 & 1997; Mawani, 2003a), to the firm's disclosure behavior around the granting of the options (e.g., Aboody and Kasznik, 2000) as well as the tax and accounting income consideration for the cancellation of executive stock options (e.g., Mawani 2003b). However, very few (e.g., HRS; Kato Kato

loyal servant of the Green Hornet. [Radio: “The Green Hornet” in Buxton, 102–103]

See : Loyalty
 et al, 2005; Sanders San´ders

n. 1. An old name of sandalwood, now applied only to the red sandalwood. See under Sandalwood.
 and Hambrick, 2007) have attempted to provide direct evidence of the impact of executive stock options on the firm's earnings. HRS conclude that every dollar of stock options (using Black-Scholes values) granted to the top five executives contributes $3.71 to future operating earnings Operating Earnings

Profits after subtracting expenses such as marketing, cost of goods sold, administration and general operating costs from revenue.

Notes:
Tax and interest expenses are not subtracted - operating earnings are synonymous with EBIT (earnings before
 of the company over the next five years. Kato et al. (2005), using Japanese data and an event study methodology, also conclude that operating performance improves with stock options. However Sanders and Hambrick (2007) have shown that while stock options do affect CEO (1) (Chief Executive Officer) The highest individual in command of an organization. Typically the president of the company, the CEO reports to the Chairman of the Board.  behaviors, their heavy use produces more losses than gains. Other agency theorists wondered whether the traditional ESO ESO European Southern Observatory
ESO Educación Secundaria Obligatoria (Spain: compulsory secondary education)
ESO European Organisation for Astronomical Research in the Southern Hemisphere
ESO Edmonton Symphony Orchestra
 plans for executives are not leading to creative ways of managing earnings while ignoring the cost of equity (Jensen Noun 1. Jensen - modernistic Danish writer (1873-1950)
Johannes Vilhelm Jensen
, Murphy, and Wruck, 2004).

These mixed results are manifestations that the question of whether stock options induce in·duce
v.
1. To bring about or stimulate the occurrence of something, such as labor.

2. To initiate or increase the production of an enzyme or other protein at the level of genetic transcription.

3.
 mangers to take appropriate actions is still not settled. Researchers using the incentive alignment hypothesis argue that stock options compensation could be utilized to reduce the incentives asymmetry Asymmetry

A lack of equivalence between two things, such as the unequal tax treatment of interest expense and dividend payments.
 between managers and shareholders (e.g., Rajgopal and Shevlin, 2002; HRS; Mawani, 2003a). However, other researchers using the rent extraction hypothesis argue that this compensation package can be a conduit conduit /con·du·it/ (kon´doo-it) channel.

ileal conduit  the surgical anastomosis of the ureters to one end of a detached segment of ileum, the other end being used to form a stoma on the
 of transferring wealth from shareholders to management/top executives (e.g., Johnson 2003; Aboody and Kasznik, 2000; Baker, Collins, and Reitenga, 2003).

Our study is motivated mo·ti·vate  
tr.v. mo·ti·vat·ed, mo·ti·vat·ing, mo·ti·vates
To provide with an incentive; move to action; impel.



mo
 by the need to fill this important gap in the literature with the intent to examining the impact of granting options to top corporate executives on the firms' earnings and the probability of bankruptcy, and by extension the value of the firm. We build on the future operating earnings-based model used by HRS which we believe has advantages over models using ex-post stock price performance like that used by Kato et. (2005) Future operating earnings do not suffer from stockholder expectation problem embedded Inserted into. See embedded system.  in ex-post price performance of shares. We adjust HRS's model for challenges suggested by HRS and Larker lark 1  
n.
1. Any of various chiefly Old World birds of the family Alaudidae, especially the skylark, having a sustained, melodious song.

2. Any of several similar birds, such as the meadowlark.
 (2003). We use the nondiscretionary component of earnings to avoid problems caused by earnings management. As HRS recognize, if some firms overstate or understate un·der·state  
v. un·der·stat·ed, un·der·stat·ing, un·der·states

v.tr.
1. To state with less completeness or truth than seems warranted by the facts.

2.
 earnings the results "might reflect earnings management as a function of ESO grant values rather than economic payoffs" (HRS, pp 37). We also took into account the alternative "forward-looking" research design suggested by Larcker (2003) to address similar research questions raised by HRS.

Furthermore, we use Altman's Z-score to test suggestions in the literature that ESOs induce managers to take too many risks and may cause financial distress Financial distress

Events preceding and including bankruptcy, such as violation of loan contracts.
. We use the probability of bankruptcy represented by the Altman's Z-score as a proxy for a change in the cost of equity. In effect, Altman's Z-score is inversely related to the cost of equity. The higher the Altman's Z-Score, the lower is the cost of equity. Results from our models are consistent with the incentive alignment hypothesis and are inconsistent with the overall conclusion of Sanders and Hambrick (2007) that stock options cause more losses than gains. However, they are consistent with Sanders and Hambrick (2007)'s less emphasized result that moderate levels of stock options (20% to 50%) do actually induce executives to become more risk neutral (less risk averse Risk Averse

Describes an investor who, when faced with two investments with a similar expected return (but different risks), will prefer the one with the lower risk.

Notes:
A risk averse person dislikes risk.
) with performance symmetrically sym·met·ri·cal   also sym·met·ric
adj.
Of or exhibiting symmetry.



sym·metri·cal·ly adv.

Adv. 1.
 divided between losses and gains. The overall implication of our results is that, at least in our sample of firms, partly compensating top executives with stock options not only induces them to improve earnings, it also motivates them to take moderate risks.

The rest of the paper proceeds as follows. Section 2 provides the theoretical background for the study and the hypotheses tested. Research methodology and design are the subjects of section 3. Section 4 provides the results and findings of the study. The final section provides a summary and the potential limitations/constraints that this study may face.

THEORETICAL BACKGROUND

Executive compensation constitutes a typical problem domain for agency theory. The relationship between the shareholders and the executives of a firm is one in which the two groups have partly differing goals and risk preferences. Executives are thought to be more risk averse than shareholders. This is due to the likelihood that executives, whose incomes and reputation are tied to their firms, may not have as many opportunities as shareholders to effect appropriate levels of diversification Diversification

A risk management technique that mixes a wide variety of investments within a portfolio. It is designed to minimize the impact of any one security on overall portfolio performance.

Notes:
Diversification is possibly the greatest way to reduce the risk.
 for themselves (Eisenhardt, 1989). Shareholders are more likely to be risk neutral, while executives are more likely to be risk averse. The result would be that executives avoid profitable projects with a probability of a downside Downside

The dollar amount by which the market or a stock has the potential to fall.

Notes:
You might hear someone say that the downside on stock XYZ is $10. What that means is that the stock could fall by this amount if things got bad.
, which may lead to lower returns. Consistent with seminal seminal /sem·i·nal/ (sem´i-n'l) pertaining to semen or to a seed.

sem·i·nal
adj.
Of, relating to, containing, or conveying semen or seed.
 works in agency theory (such as Jensen and Meckling, 1976), the solution to the problem is to move the executives' risk-averse Risk-averse

Describes an investor who, when faced with two investments with the same expected return but different risks, prefers the one with the lower risk.
 preferences to risk-neutrality. Stock options, not only add a feature of outcome-orientation to any salary contract, which is primarily behavior-oriented, but they also increase the firm ownership by executives which decreases opportunism Opportunism
Arabella, Lady

squire’s wife matchmakes with money in mind. [Br. Lit.: Doctor Thorne]

Ashkenazi, Simcha

shrewdly and unscrupulously becomes merchant prince. [Yiddish Lit.
. Basically, any action taken by executives to reward themselves will simultaneously reward the shareholders. This is the incentive alignment perspective that makes some researchers (e.g. HRS; Kato et al) to argue that the motivational potentials of stock options should motivate top executives to act in a way that maximizes firm value.

However, the question that agency theorists were grabbling with lately is whether the resultant This article is about the resultant of polynomials. For the result of adding two or more vectors, see Parallelogram rule. For the technique in organ building, see Resultant (organ).

In mathematics, the resultant of two monic polynomials
 executive behavior includes sensible risk taking (Jensen et al, 2004; HRS; Sanders and Hambrick, 2007). Researchers have shown that, while stock options have induced induced /in·duced/ (in-dldbomacst´)
1. produced artificially.

2. produced by induction.

induced,
adj artificially caused to occur.


induced

induction.
 executives to take more risks, there are doubts that these risks are value enhancing. Sanders and Hambrick (2007) show that moderate levels of stock options (20% to 50%) do induce executives to become more risk neutral (less risk averse) with performance symmetrically divided between losses and gains. On the other hand, more option-loaded executives produced more big losses than big gains (Sanders and Hambrick, 2007, p.1070). The extreme results of high option levels are plausible given the fact that stock options bestow be·stow  
tr.v. be·stowed, be·stow·ing, be·stows
1. To present as a gift or an honor; confer: bestowed high praise on the winners.

2.
 on holders the opportunity to participate in the improved or enhanced share price without directly partaking in the downside loss, if it eventually occurs.

RESEARCH METHODOLOGY AND DESIGN

Consistent with the dictates of agency theory, the unit of analysis for this problem domain is the contract between the shareholders (principal) and the executives (agents). Specifically, we will look at the impact of compensating top executives with stock options on earnings and probability of bankruptcy of the firm. Earnings and probability of bankruptcy have direct impact on firm value. However, instead of looking at the value (2) of the firm directly, we will look at the accounting return and a proxy for the risk incurred in earning that return (3). A change in the expected earnings or a change in the rate used to discount the future earnings or the combination of changes could cause a change in the value of the firm. In other words Adv. 1. in other words - otherwise stated; "in other words, we are broke"
put differently
, an increase (decrease) in earnings or decrease (increase) in discount rate will lead to an increase (decrease) in the value of the firm, all else equal. Significant increase in the probability of bankruptcy will normally increase the required rate of return used to discount future earnings thus reducing the value of the firm. However, researchers are yet to agree on whether or not the use of employee/executive stock option is good for the shareholders and how it affects those components of firm value [see for example, Johnson, 2003; Mawani, 2003a; HRS; Kato et al, 2005; Sanders and Hambrick, 2007). Testing for performance both in terms of return (earnings) and in terms of risk may yield more compelling evidence of stock option compensation efficacy.

Earnings

Earnings, in the accounting sense, are generally the difference between revenues and expenses of operating activities. Due to the tendencies of executives/managers to take leverage of their discretionary powers in smoothing earnings, research in the earnings management literature has indicated that reported earnings might not be persistent and thus might not reflect the 'true' earnings components. To estimate "true earnings", accounting scholars proposed several methods to remove the effect of discretionary components of earnings from the reported earnings (see for example, Dechow et al, 1995; Jones, 1991; Gaver, 1995; Reitenga et al, 2002; Baker et al, 2003; Kang KANG Kansas Air National Guard  and Sivaramakrishnan, 1995; Cohen cohen
 or kohen

(Hebrew: “priest”) Jewish priest descended from Zadok (a descendant of Aaron), priest at the First Temple of Jerusalem. The biblical priesthood was hereditary and male.
 and Zarowin, 2010). In this study, we follow the approaches of Dechow et al (1995) to calculate 'nondiscretionary earnings' as a proxy for 'true' earnings. Therefore, in order to capture the effect of our measure of earnings on the firm's value vis-a-vis executive stock options compensation, we put forward the following two hypotheses that relate to reported earnings ([H.sub.1]) and to nondiscretionary (true) earnings ([H.sub.2]).

[H.sub.1]: Ceteris paribus Ceteris Paribus

Latin phrase that translates approximately to "holding other things constant" and is usually rendered in English as "all other things being equal". In economics and finance, the term is used as a shorthand for indicating the effect of one economic variable on
, the higher the use of Executive stock options, the higher the reported operating earnings of the firm.

In testing this hypothesis, we try to replicate rep·li·cate
v.
1. To duplicate, copy, reproduce, or repeat.

2. To reproduce or make an exact copy or copies of genetic material, a cell, or an organism.

n.
A repetition of an experiment or a procedure.
 the results of HRS after adjusting for some missing variables suggested by Larker (2003). Hypothesis 2 adjusts HRS for earnings management.

[H.sub.2]: Ceteris paribus, the higher the use of Executive stock options, the higher the nondiscretionary earnings of the firm.

In hypothesis 1, the dependent measure is the reported operating income Operating Income

The profit realized from a business' own operations.

Notes:
This would not include income from things such as investments in other firms. Also referred to as operating profit or recurring profit.
 and the estimated empirical model, using least squares regression regression, in psychology: see defense mechanism.
regression

In statistics, a process for determining a line or curve that best represents the general trend of a data set.
, is presented as:

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE re·pro·duce  
v. re·pro·duced, re·pro·duc·ing, re·pro·duc·es

v.tr.
1. To produce a counterpart, image, or copy of.

2. Biology To generate (offspring) by sexual or asexual means.
 IN ASCII ASCII or American Standard Code for Information Interchange, a set of codes used to represent letters, numbers, a few symbols, and control characters. Originally designed for teletype operations, it has found wide application in computers. ] (1)

Where:

OPINC = Operating Income before depreciation scaled by Sales of firm i at time t.

TA = Total Assets of firm i at time t

BSO BSO Bilateral salpingo-oophorectomy. Excision of both ovaries  = Black-Scholes value of executive stock options granted to top 5 Executives. BSO is also squared to adjust for an observed non-linearity in the relationship between BSO and OPINC.

R&D = Research and development expenses of firm i during the year t - k (k = 0 - 5)

[sigma][(OPINC).sub.i,t-1] = Standard deviation of earnings measures estimated over the prior 5 year, for firm i.

S = is the annual sales in time t.

Equation (1) above is the baseline The horizontal line to which the bottoms of lowercase characters (without descenders) are aligned. See typeface.

baseline - released version
 model of HRS for examining the incentives potential effects of executive stock options. However, this baseline model does not control for previous firm's performance and as argued by Larcker (2003), failure to control for previous firm's performance ([OPINC/S.sub.i,t-1]) might be an essential omission omission n. 1) failure to perform an act agreed to, where there is a duty to an individual or the public to act (including omitting to take care) or is required by law. Such an omission may give rise to a lawsuit in the same way as a negligent or improper act.  in the HRS baseline model. Therefore, in the spirit of Larcker (2003) argument, we control for firm's previous performance and thus modify equation 1 as:

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (2)

In order to examine the effect of earnings management vis-a-vis the use of executive stock options, we replace OPINC/S in equation 1 and 2 with NDE/S (nondiscretionary earnings) as in

(3) and (4) below:

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (3)

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (4)

All variables are as described in (1). The industry dummies are based on a two-digit SIC code classification, unless otherwise stated, while the year dummies represents the fiscal year when operating/nondiscretionary is measured. All variables are scaled by sales to control for possible size effects and the possibility of heteroscedascticity. The standard deviation estimated over the prior 5 years is expected to control for the possible relation between firm risk and future earnings. This is consistent with Core et al (1999) specification (see also HRS). Other compensation related variables, such as cash compensation and the number of exercisable options in the money, that could simultaneously impact a firm's performance are also controlled for in the sensitivity analysis section.

Nondiscretionary earnings are measured as nondiscretionary accrual accrual,
n continually recurring short-term liabilities. Examples are accrued wages, taxes, and interest.
 plus cash flow from operations Cash flow from operations

A firm's net cash inflow resulting directly from its regular operations (disregarding extraordinary items such as the sale of fixed assets or transaction costs associated with issuing securities), calculated as the sum of net income plus noncash expenses
. Nondiscretionary accrual is measured using modified Jones model as specified by Dechow et al (1995) and Gaver et al (1995). This is calculated as:

[NDA.sub.it] = [a.sub.i] + [b.sub.1i]([DELTA][REV.sub.it] - [DELTA][REC.sub.it]) + [b.sub.2i][PPE PPE (Brit) n abbr (Univ) (= philosophy, politics, and economics) → Studiengang bestehend aus Philosophie, Politologie und Volkswirtschaft

PPE n abbr (BRIT ) (SCOL
.sub.it] (5a)

The estimates of [a.sub.i], [b.sub.1], [b.sub.2] are generated from the following model:

[TAC.sub.it] = [a.sub.i] + [b.sub.1i]([DELTA][REV.sub.it] - [DELTA][REC.sub.it]) + [b.sub.2i][PPE.sub.it] + [[epsilon].sub.it] (5b)

[NDE NDE Nondestructive Examination
NDE No Diplomatic Exchange (US Department of State)
NDE Near Death Experience
NDE Nondestructive Evaluation (ultrasound material evaluation) 
.sub.it] = [NDA.sub.it] + [COP COP

In currencies, this is the abbreviation for the Colombian Peso.

Notes:
The currency market, also known as the Foreign Exchange market, is the largest financial market in the world, with a daily average volume of over US $1 trillion.
.sub.it] (5c)

Where:

[NDA.sub.it] = Nondiscretionary accruals Accruals

Accounts on a balance sheet that represent liabilities and non-cash-based assets used in accrual-based accounting. These accounts include, among many others, accounts payable, accounts receivable, goodwill, future tax liability and future interest expense.
;

[TAC.sub.it] = total accruals in year t for firm i, and it is calculated as:

[TAC.sub.it] = [DELTA][CA.sub.t] - [DELTA][Cash.sub.t] - [DELTA][CL.sub.t] + [DELTA][CM.sub.t] + [DELTA]Income Taxes [Payable.sub.t] - Depreciation and Amortization [Expense.sub.t]

[NDE.sub.it] = Nondiscretionary earnings;

[COP.sub.it] = cash flow from operations;

[DELTA][REV.sub.it] = revenues in year t less revenues in year t - 1 for firm i;

[DELTA][REC.sub.it] = receivables Receivables

An asset designation applicable to all debts, unsettled transactions or other monetary obligations owed to a company by its debtors or customers. Receivables are recorded by a company's accountants and reported on the balance sheet, and they and include all debts owed
 in year t less receivables in year t - 1 for firm i;

[DELTA] is the change and computed as the difference between time t and t - 1.

[PPE.sub.it] = gross property, plant, and equipment at the end of year t for firm i;

CA = Current Assets Current Assets

Appearing on a company's balance sheet, it represents cash, accounts receivable, inventory, marketable securities, prepaid expenses, and other assets that can be converted to cash within one year.
 

CL = Current Liabilities Current Liabilities

Usually appearing on a company's balance sheet, it represents the amount owed for interest, accounts payable, short-term loans, expenses incurred but unpaid, and other debts due within one year.
 

CM = current maturities of long term debt.

[[epsilon].sub.it] = error term for firm i;

The above baseline model (and by extension other models, excluding 5) are termed as "backward-looking" design by Larcker (2003) and so he suggests that future research could explore the potentials of "forward-looking" models. Taking up the challenge, and using almost all the variables, we use an alternative model choice to the HRS baseline model. The advantages of such "forward-looking" model include the opportunity to efficiently maximize the sample size.

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (6a)

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (6b)

Similarly for the nondiscretionary earnings, we have:

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (7a)

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (7b)

(Definitions of variables are the same as described above.)

Measure of Risk

The probability of bankruptcy will be used to capture the responsiveness of the firm's cost of discounting the earnings to the use of stock options to compensating top executives. Johnson (2003) argues that the use of stock options may encourage managers to pursue suboptimal Suboptimal
A solution is called suboptimal if a part of the solution has been optimized without regards to the overall objective.
 goals that maximize firms' earnings in the short term at the expense of long term viability of the firm. The crest crest, in feudal livery, an ornament of the headpiece that afforded protection against a blow. The term is incorrectly used to mean family coat of arms. Crests were widely used in the 13th cent.  of the argument is that, since stock options provide the executives an upside potential Upside potential

The amount by which analysts or investors expect the price of a security may increase.


upside potential

The potential price or gain that may be expected in a security or in a security average, generally stated as the dollar
 without exposing them to a commensurate com·men·su·rate  
adj.
1. Of the same size, extent, or duration as another.

2. Corresponding in size or degree; proportionate: a salary commensurate with my performance.

3.
 risk of the downside, managers may take huge risks (Sanders and Hambrick, 2007). On the other hand, if the claim of agency theorists that the use of stock options ameliorates agency problems by aligning the incentives of managers to those of the shareholders holds, then firms whose executives are compensated more with stock options should have lower probability of bankruptcy. As a result, the true relationship between the use of stock options and the probability of bankruptcy becomes an empirical question. We put forward the following hypothesis in the affirmative AFFIRMATIVE. Averring a fact to be true; that which is opposed to negative. (q.v.)
     2. It is a general rule of evidence that the affirmative of the issue must be proved. Bull. N. P. 298 ; Peake, Ev. 2.
     3.
 while acknowledging the possibility of no or negative effect for the aforementioned a·fore·men·tioned  
adj.
Mentioned previously.

n.
The one or ones mentioned previously.


aforementioned
Adjective

mentioned before

Adj. 1.
 reasons.

[H.sub.3]: Ceteris paribus, the higher the use of Executive stock options, the lower the probability of bankruptcy

We use the following equation to empirically test the effect of stock options hypothesized in H3.

[PROBNKP.sub.it] = [[micro].sub.0] + [[micro].sub.1][BSO.sub.it] + [[micro].sub.2][ERNVOL.sub.it] + [[micro].sub.3][SIZE.sub.it] + [[micro].sub.4][GROWTH.sub.it] + [[micro].sub.5][LEV.sub.it] + [[OMEGA 1. (programming) Omega - A prototype-based object-oriented language from Austria.

["Type-Safe Object-Oriented Programming with Prototypes - The Concept of Omega", G. Blaschek, Structured Programming 12:217-225, 1991].
2.
].sub.it] (8)

Where:

[PROBNKP.sub.it] = probability of bankruptcy of firm i at time t. This is measured using the Altman Alt·man   , Robert Born 1925.

American film director and screenwriter whose film credits include M*A*S*H (1970), for which he won an Academy Award, and The Player (1992).
 (1968) Z score.

[ERNVOL.sub.it] = earnings volatility of firm i at time t. This is measured as the standard deviation of the firm's earnings per share over the sample period.

[SIZE.sub.it] = size of firm i at time t. This is measured as total assets at [sub.t-1]

[LEV.sub.it] = leverage of firm i at time t. This is measured as the prior year long term debt to total equity capital of the firm.

[GROWTH.sub.it] = captures the market to book value over the prior 5 years.

[[OMEGA].sub.it] = error term.

Industries dummies will also be used to capture and control for the cross sectional sec·tion·al  
adj.
1. Of, relating to, or characteristic of a particular district.

2. Composed of or divided into component sections.

n.
 industry effects.

The inclusion of [BSO.sub.it] in equation (8) is only an attempt to establish empirical relationship In science, an empirical relationship is one based solely on observation rather than theory. An empirical relationship requires only confirmatory data irrespective of theoretical basis. , not causation causation

Relation that holds between two temporally simultaneous or successive events when the first event (the cause) brings about the other (the effect). According to David Hume, when we say of two types of object or event that “X causes Y” (e.g.
, between the use of executive stock options and the failure of the firm. There are too many reasons and potential causes of corporate failures/bankruptcy that will prevent us from claiming causality causality, in philosophy, the relationship between cause and effect. A distinction is often made between a cause that produces something new (e.g., a moth from a caterpillar) and one that produces a change in an existing substance (e.g.  in this regard.

There is consistent evidence in the literature that the degree of firms' earnings volatility is an increasing function (Math.) a function whose value increases when that of the variable increases, and decreases when the latter is diminished; also called a monotonically increasing function ltname>.

See also: Increase
 of the firms cost of capital (see for example, Patell, 1976; Goel Go´el   

a. 1. Yellow.
 & Thakor, 2003; Lacina, 2004; DeFond & Hung, 2003). ERNVOL is added to capture the effect of earnings volatility. Earnings volatility is a decreasing function of the quality of earnings in that the more volatile a firm's earnings are, the noisier the investors' assessments of such earnings with the potential consequence of diminishing di·min·ish  
v. di·min·ished, di·min·ish·ing, di·min·ish·es

v.tr.
1.
a. To make smaller or less or to cause to appear so.

b.
 the earnings' perceived quality. As a result, before informed investment decisions could be made, additional search costs Search costs

Costs associated with locating a counterparty to a trade, including explicit costs (such as advertising) and implicit costs (such as the value of time). Related: Information costs.
 are implicitly imposed on investors as they will require additional sources of information to allow for desirable interpretations and then make informed judgments of such firm's volatile earnings. Goel and Thakor (2003) suggest that "an increase in the volatility of reported earnings will magnify mag·ni·fy
v.
To increase the apparent size of, especially with a lens.
 these shareholders' trading losses The following contains a list of trading losses which eventually forced major corporations to go bankrupt or restructure parts of their organisation. This list is not exhaustive. ." No doubt, such additional costs will be impounded in the required rate of returns for investment in such firms with the attendant ATTENDANT. One who owes a duty or service to another, or in some sort depends upon him. Termes de la Ley, h.t. As to attendant terms, see Powell on Morts. Index, tit. Attendant term; Park on Dower, c. 1 7.  increase in the firm's cost of capital. Alternative explanation for the possible increase in the cost of capital as a result of a firm's earnings volatility could be that since firms with high volatile earnings will need to provide other types of disclosures and information to market participants so as to mitigate mit·i·gate
v.
To moderate in force or intensity.



miti·gation n.
 the possible negative market reactions, such contingent additional information are not costless. (4)

LEV is expected to capture the operational uncertainty caused by cost of debt. Ahmed et al (2002) empirically document that operational uncertainty is one of the sources of "bondholder-shareholder conflicts over dividend costs" and that mitigating mit·i·gate  
v. mit·i·gat·ed, mit·i·gat·ing, mit·i·gates

v.tr.
To moderate (a quality or condition) in force or intensity; alleviate. See Synonyms at relieve.

v.intr.
To become milder.
 such conflicts could translate into the reduction in the firm's debt costs, and thus consequently increasing the value of the firm, all else equal. Titman tit·man  
n. New England & Upstate New York
1. A runt, especially one of a litter of pigs.

2. A small person. See Regional Note at tit1.
 and Wessels (1988) as cited by Dittmar (2004) provide evidence that the firm's cost of debt increases the probability of a firm's susceptibility susceptibility

the state of being susceptible. Refers usually to infectious disease but may be to physical factors such as wetting or to psychological factors such as harassment.
 to bankruptcy or financial distress (See Ngo, 2002; Mao, 2003).

GROWTH captures the relationship between probability of bankruptcy and book-to-market values of firms. The extant literature Extant literature refers to texts that have survived from the past to the present time. Extant literature can be divided into extant original manuscripts, copies of original manuscripts, quotations and paraphrases of passages of non-extant texts contained in other works,  shows that firms with high probability of bankruptcy Z-score on average have low book-to-market values (see Hahn Hahn   , Otto 1879-1968.

German chemist. He won a 1944 Nobel Prize for his work on atomic fission.

Noun 1. Hahn - German chemist who was co-discoverer with Lise Meitner of nuclear fission (1879-1968)
Otto Hahn
 et al, 2010; and Zaretzky & Zumwalt Zumwalt can refer to one of the following:
  • Elmo R. Zumwalt, Jr., a former admiral in the U.S. Navy
  • Fort Zumwalt in St. Charles County, Missouri, now a state historic site
, 2007 for a review of this literature).

The proxy for the probability of bankruptcy (PROBNKP it), the Altman (1968) Z score, will be calculated for individual sample firms over the sample period as follows:

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (9)

Generally, higher Z-score corresponds to lower probability of bankruptcy. If a company has a Z-Score above 3, it is considered to be healthy and, therefore, unlikely to enter bankruptcy. If the score is lower than 1.8, the firm is in danger of bankruptcy. But if the Score is between 1.8 and 3, it is in a grey area (Altman, 1968)

Sample Selection

This study covers all US firms with available data in the Execucomp database as well as the Compustat '''Standard & Poor's Compustat® is a database of financial, statistical and market information on active and inactive companies throughout the world. Compustat® data has a reputation for extensive coverage, standardization, expertise and timeliness.  tapes. The Execucomp database contains the compensation data for the top five executives of individual firms in the S&P 1500 (comprising those in the S&P 500 index, S&P 400 mid cap index and the S&P 600 small cap index). This data coverage begins in 1992. We extract the necessary data regarding the Black-Scholes value of an option from this database. For the entire model, we start with an initial sample of 2,507 firms with 17,970 firm years.

After interpolating and intersecting in·ter·sect  
v. in·ter·sect·ed, in·ter·sect·ing, in·ter·sects

v.tr.
1. To cut across or through: The path intersects the park.

2.
 data from the two databases, deleting missing observations and conducting other data screening exercises, we have for the 'backward-looking' research design 858 firms with 2,579 firm-years. The forward-looking design comprises three different model categories viz viz - A visual language for specification and programming.

["viz: A Visual Language Based on Functions", C.M. Holt, 1990 IEEE Workshop on Visual Langs, Oct 1990, pp.221-226].
: n + 1, Sum n + 1 + 2 and Sum n + 1 + 2 + 3 (where n is the grant year). Therefore, the first has 1,666 firms spanning 8,384 firm-years; the second has 1,476 firms with 6,666 firm-years and the third has 1,283 firms covering 5,357 firm-years (5). We believe that the larger sample size and the longer sample period relative to HRS better maximize the generalizability of findings in this critically important area of compensation research in empirical accounting.

To avoid complications caused by differences in reporting rules, the sample firms are required to be incorporated in the US. This is consistent with Matsunaga (1995). Also, regulated firms such as utilities companies (SIC codes 4900-4999) and financial institutions (SIC codes 6000-6099) are excluded so as to control for the differential incentives and motivational situations faced by executives operating in those regulatory environments relative to their counterparts in the non-regulated industries.

ANALYSES AND RESULTS

In this section, we present the empirical results obtained in the study and discus discus /dis·cus/ (dis´kus) pl. dis´ci   [L.] disk.

dis·cus
n. pl. dis·ci
A flat circular surface; a disk.



discus

pl. disci [L.]

1.
 the implications of the findings for extant ex·tant  
adj.
1. Still in existence; not destroyed, lost, or extinct: extant manuscripts.

2. Archaic Standing out; projecting.
 and future research in the area. Commencing with the descriptive statistics descriptive statistics

see statistics.
 for the sampled firms in the 'backward-looking model, panel A of table 1 shows that the average firm in the sample generates annual sales worth of 5.4 billion (median $1.7 billion) with an operating margin Operating Margin

A ratio used to measure a company's pricing strategy and operating efficiency.

Calculated by:
 of approximately 15%. The average firm in the sample has assets worth $5 billion (median $1.6 billion) with asset turnover rate of approximately 0.90. This suggests that firms in this category are fairly large and profitable. The average value (BSO) of the executive stock options granted to the top five executives of the sample firms is $7.758 million (median $2.7 million). This is approximately 0.4% of operating revenues, which is very similar to that reported in HRS.

Results

The coefficients from the regression and implied sensitivity analyses undertaken for the respective models to estimate payoffs using Black-Scholes values of executive stock option

Tables 2, 3 and 4, show information for firms in the 'forward-looking' models. Similar conclusion about size and profitability of firms in the respective sample category could be reached with the above descriptive information. Panel B of these tables shows the correlation matrix Noun 1. correlation matrix - a matrix giving the correlations between all pairs of data sets
statistics - a branch of applied mathematics concerned with the collection and interpretation of quantitative data and the use of probability theory to estimate population
 of the individual variables of interest in the respective models and virtually all the correlations are significant at the conventional significance thresholds.

Regression Results

The coefficients from the regression and implied sensitivity analyses undertaken for the respective models to estimate payoffs using Black-Scholes values of executive stock option grants are presented in tables 5 to 14 for both backward-looking and forward-looking models. Discussion of the results vis-a-vis their implications are concurrently presented as well.

Recall that due to the nonlinearity of the executive stock options and the respective performance measures, a second order term was introduced. BSO/S is the first order term while its square is the second order-term. Consistent with the findings of HRS, the regression coefficients of this second-order term was significantly negative in all the model specifications. This significantly negative coefficient coefficient /co·ef·fi·cient/ (ko?ah-fish´int)
1. an expression of the change or effect produced by variation in certain factors, or of the ratio between two different quantities.

2.
 suggests concavity con·cav·i·ty
n.
A hollow or depression that is curved like the inner surface of a sphere.


concavity,
n 1. the condition of being concave.
n 2.
, meaning that executive stock option grants increase performance at a reducing rate. Arguably ar·gu·a·ble  
adj.
1. Open to argument: an arguable question, still unresolved.

2. That can be argued plausibly; defensible in argument: three arguable points of law.
, the inclusion of the second-order term does appear to correct omitted variable bias and does not seem to have induced our results. This is because there was no single situation of sign-switching of any of the regression coefficients of the primary variable of interest (which is BSO/S), the first-order term, as a result of the inclusion of the second-order term, but instead, the measure of goodness of fit Goodness of fit means how well a statistical model fits a set of observations. Measures of goodness of fit typically summarize the discrepancy between observed values and the values expected under the model in question. Such measures can be used in statistical hypothesis testing, e.  statistic statistic,
n a value or number that describes a series of quantitative observations or measures; a value calculated from a sample.


statistic

a numerical value calculated from a number of observations in order to summarize them.
 (adjusted R-Square) is consistently improved across all models. Similarly, we include lag of dependent measures in the respective models so as to control for prior year performance. This is important because of the mean reverting re·vert  
intr.v. re·vert·ed, re·vert·ing, re·verts
1. To return to a former condition, practice, subject, or belief.

2. Law To return to the former owner or to the former owner's heirs.
 nature of the performance measures. Recall that HRS do not control for this in their baseline regression model which is primarily 'backward-looking'. Therefore, as a result of the compelling econometric e·con·o·met·rics  
n. (used with a sing. verb)
Application of mathematical and statistical techniques to economics in the study of problems, the analysis of data, and the development and testing of theories and models.
 justification for the inclusion of the second order term, as well as lagged performance measures, which is consistent with theoretical reasoning, considerable amount of our discussions will centre on the nonlinear A system in which the output is not a uniform relationship to the input.

nonlinear - (Scientific computation) A property of a system whose output is not proportional to its input.
 coefficients of both prior and current performance measures with occasional references to the linear results for comparison purposes, where necessary.

Backward-looking design

Tables 5 and 6 contain the regression coefficients of the lagged design in panel A. Linear specifications of the respective models are presented in columns 1 and 2, while their nonlinear counterparts are contained in columns 3 and 4. There are 858 firms with 2,579 usable USable is a special idea contest to transfer US American ideas into practice in Germany. USable is initiated by the German Körber-Stiftung (foundation Körber). It is doted with 150,000 Euro and awarded every two years.  firm year observations.

The coefficients of the primary variable of interest in the model which is the additive additive

In foods, any of various chemical substances added to produce desirable effects. Additives include such substances as artificial or natural colourings and flavourings; stabilizers, emulsifiers, and thickeners; preservatives and humectants (moisture-retainers); and
 sum of BSO/S, and perhaps the [(BSO/S).sup.2], show positive and negative directions respectively in all the model specifications. Looking at the nonlinear without previous performance measures of column 3, panel A of tables 5 and 6, for reported performance, the additive sum of these variables are respectively 0.348 and -0.171; 0.317 and -0.187 for nondiscretionary earnings. Column 4 shows the nonlinear with previous performance measures results. It shows the additive sum coefficients for BSO/S and [(BSO/S).sup.2] as 0.408 and -0.115, respectively in the reported performance model and 0.213 and -0.042 in the nondiscretionary earnings model. All these coefficients are highly significant.

The positive direction of these coefficients with respect to the first order term (BSO/S) implies positive contributions of executive stock options grants to both of our performance measures (reported earnings and nondiscretionary earnings). In other words, regardless of which earnings performance measures (reported, or 'true' earnings), corporate use of executive stock options positively impacts corporate performance. These findings provide extended, stronger and corroborative cor·rob·o·rate  
tr.v. cor·rob·o·rat·ed, cor·rob·o·rat·ing, cor·rob·o·rates
To strengthen or support with other evidence; make more certain. See Synonyms at confirm.
 support for the findings of HRS. If the coefficients on BSO/S were to have been negative, consistent with the agency theory literature, then there is evidence of rent extraction.

Notwithstanding the above assertion, it is important to note the impact of introducing previous performance measures on the results. Column 4 shows that introducing lagged dependent variable actually increases BSO contributions for reported earnings (from 0.348 to 0.408), but reduces same contribution with respect to nondiscretionary earnings (from 0.317 to 0.213). We interpret these findings to mean that the improvement in earnings attributable to the granting of stock options to executives is not as high as implied by reported earnings when one controls for earnings management and prior year's earnings performance.

Panel B and C provide corroborative evidence of the results presented in panel A of tables 5 and 6. These panels show economic sensitivity (following HRS) of various BSO distributions to the performance measures. This is computed as the change in each of the dependent measures scaled by change in BSO/S, showing the economic impact, i.e. the dollar value, on performance measures of changing the median BSO up or down to next quartile Quartile

A statistical term describing a division of observations into four defined intervals based upon the values of the data and how they compare to the entire set of observations.

Notes:
Each quartile contains 25% of the total observations.
 cutoff, which in this instance is first and third quartile respectively. Specifically, focusing on the reported operating income without prior performance measure, if one moves from the quartile 1 BSO/S cutoff value of 0.0005 to the median of 0.0012, the dependent measure, OPINC/S, would increase from 0.0002 to 0.0004 indicating an implied sensitivity of 0.35. Similarly, the equivalent sensitivity for moving from the median to the 3rd quartile cutoff is 0.35, note that without approximating to two decimal Meaning 10. The numbering system used by humans, which is based on 10 digits. In contrast, computers use binary numbers because it is easier to design electronic systems that can maintain two states rather than 10.  places, in absolute decimal terms, this value is less than 0.35. According to according to
prep.
1. As stated or indicated by; on the authority of: according to historians.

2. In keeping with: according to instructions.

3.
 HRS, the small slide in the implied sensitivities due to a shift from the median to quartile 3 of BSO/S indicates that the second-order effect of BSO/S is "economically" inconsequential in·con·se·quen·tial  
adj.
1. Lacking importance.

2. Not following from premises or evidence; illogical.

n.
A triviality.
, but that failure to consider this second-order term "appears to create a significant omitted variable in the linear specification".

From the implied sensitivity calculations, our results show that there is positive economic contribution of executive stock option grants to firm performance measures. For example, without prior performance measures, a dollar grant of executive stock options to top 5 corporate executives increase future reported operating performance by $1.35 and future nondiscretionary earnings by $1.32. With lagged performance measures, future reported operating performance increases by S1.41 and nondiscretionary earnings by $1.21 Overall, while the BSO-performance relation is positive, there is still some evidence of earnings management. For example, while the reported income shows $1.41 increment To add a number to another number. Incrementing a counter means adding 1 to its current value.  in BSO contribution to future operating performance, if the concept of 'true' earnings is considered as in nondiscretionary earnings, the contribution is only $1.21 or a reduction of 14%. This reduction is economically significant given that the average value of stock options granted by our sample firms is $7.8m in the backward model and around $4.5m in the forward model.

The other variable of interest in the empirical analysis is the research and development expenditure. R&D is an investment expenditure that should impact the future performance of the firm. Without controlling for this type of investment capital expenditure, one might run the risk of excessively attributing BSO performance payoffs (which may involve overestimating or underestimating error), hence the importance of this variable in the empirical design. Controlling for prior performance makes a difference in the sign of the coefficients of this variable in the operating income model. This thus implies that while it might appear that there is a positive contribution of the R&D expenditure to future operating performance, once prior performance is controlled for, this might not be the case. The same variable in HRS is positive (but HRS do not control for prior performance) and our result in column 4 of the panel A of table 5 challenges this result. Column 4 of table 6 also portrays a similar result. However, with respect to the nondiscretionary earnings measure, there is a consistently positive contribution of R&D expenditure to this future performance measure. If nondiscretionary earnings measure is truly a measure of 'true' earnings, then we will submit that managers do make positive net present value investment commitments in research and development expenditure.

Forward-looking design

As Larcker (2003) appropriately noted, the 'backward-looking' design approach employed by HRS is susceptible to quite a few limitations and criticisms and so can be improved upon. Some of the criticisms according to Larcker include its restrictive sample size, restrictive sample period, and the real potential reduction in the model explanatory ex·plan·a·to·ry  
adj.
Serving or intended to explain: an explanatory paragraph.



ex·plan
 power (6). He therefore suggested a 'forward-looking' research design choices.

Responding to this challenge, we will re-investigate the research question by re-specifying the empirical models using the 'forward-looking' empirical design in the following sequence: n + 1 (i.e. Year + 1), Sum n + 1 + 2 (i.e. SumYear + 1 + 2) and Sum n + 1 + 2 + 3 (i.e. SumYear + 1 + 2 + 3); where n is the grant year.

Year +1 Empirical Model

With this model, we estimate the option-performance payoffs of granting executive stock options to top 5 corporate executives in year n and the contribution of such new grants to future performance in year n+1, after controlling for necessary variables like corporate capital expenditures in tangible assets and research and development expenditure, prior performance measures as well as total cash compensation to these target executives.

There are 1,666 firms with 8,384 usable number of firm year observations for this empirical model. The regression coefficients and the implied sensitivity analysis for this model, is contained in tables 7 and 8.

The primary variable of interests are BSO/S and [(BSO/S).sup.2]. These variables show highly significant positive and negative coefficients signs respectively. For the operating income dependent measure, the coefficients are 0.373 and -0.249 without prior performance; 0.229 and 0.172 with prior performance. Nondiscretionary earnings measure has 0.247 and -0.124, and -0.147 and -0.078 for model without prior performance and that with prior performance respectively. One of the important implications of these coefficients is that the second-order term returning negative coefficients consistently in each of the models attests to the concavity nature of the BSO-performance relation, meaning that while executive stock options grants to top 5 corporate executives increase future performance, such relation is at a decreasing rate. This also attests to the nonlinear nature of the BSO-performance relation.

Another note worthy of mention is the fact that the coefficients of BSO/S in each of the models are consistently reduced when prior performances are controlled for. For example, for reported earnings dependent measure, it reduces from 0.373 to 0.229 and from 0.247 to 0.147 for nondiscretionary earnings dependent measure. This speaks to the fact that without controlling for this important variable, apart from the serious omitted variable bias that such exclusion might introduce into the models, the payoff estimates attributable to the BSO/S variable will be wrongly overestimated (7).

Similarly, it is important to mention that the coefficients of BSO/S are highest in reported operating performance measure model (0.373 and 0.229) compared to those of nondiscretionary performance measure model (0.247 and 0.147). This consistent trend in significant coefficients reduction empirically supports our conjecture CONJECTURE. Conjectures are ideas or notions founded on probabilities without any demonstration of their truth. Mascardus has defined conjecture: "rationable vestigium latentis veritatis, unde nascitur opinio sapientis;" or a slight degree of credence arising from evidence too weak or too  that performance contributions of executive stock options grants to top 5 corporate executives as indicated in the reported operating performance might be overestimated relative to concepts of 'true' earnings as reflected in nondiscretionary earnings measure. However, it is important to note that, notwithstanding the probable performance contributions overestimations, corporate grants of executive stock options positively impact future performance, whether it is accrual-earnings (susceptible to earnings management) or future performance measures that are substantially 'accrual-free'. The results of the implied sensitivity analysis contained in panels C and D of the respective tables corroborates the position above. This analysis shows that a dollar grant of executive stock options to top 5 corporate executive contributes $1.37 to future operating income without controlling for prior performance and $1.23 when prior performance is controlled for. Similarly, $1.25 and $1.15 are contributed to nondiscretionary earnings without and with prior performance respectively. These dollar contribution amounts support the discussions above concerning the need to control for prior performance on one hand, and earnings management potentials of managers to expansively ex·pan·sive  
adj.
1. Capable of expanding or tending to expand.

2. Broad in size or extent; comprehensive: expansive police powers.

3.
 maximize their option payoffs on the other hand. In all, consistent with HRS evidence, our findings make it difficult to reject the incentive alignment hypothesis of corporate executive stock option grants, as evidence supporting rent extraction hypothesis is largely absent in our findings.

Other variables in the various models display expected trend and significant coefficients characteristics. The TA/S variable produces -0.136 and -0.151 with respect to the reported operating income dependent measure without and with prior performance measures. Also, for the nondiscretionary earnings, the coefficients are -0.187 and -0.072 respectively for with or without controlling for prior performance. We believe that the negative significant coefficients of this variable is actually reflecting assets turnover characteristics and so, it might not be inappropriate to interpret the coefficients in absolute terms (Alg.) such as are known, or which do not contain the unknown quantity.

See also: Absolute
 as these significant coefficients indicate that managers productively utilize their corporate tangible assets in generating future earnings.

The coefficients of the capital expenditure on research and development expenditure (R&D/S) also show patterns that appear similar to productive corporate performance. The highly significant coefficients are 0.252 and 0.072 for reported operating income dependent measure, and 0.314 and 0.061 for nondiscretionary earnings dependent measure without and with prior performance respectively.

In addition, the variable controlling for the total cash compensation components of top 5 corporate executive, (TCC/S) shows surprising coefficients signs, in the respective models. These coefficients respectively without and with prior performance are -0.179 and -0.066, and -0.504 and -0.257 for the reported operating earnings and nondiscretionary earnings dependent measures respectively. We believe that it is important to control for this variable so as to determine whether, after remunerating top 5 corporate executives with regular salaries and cash bonuses as well as other forms of cash compensation, executive stock options grants are still capable of impacting positively future performance. HRS do not control for this variable in their baseline model (8), but we consider this a potential source of omitted variable bias and so decide to control for it in our study, especially if one considers the analytical argument of Tian Tian
 or T'ien
(Chinese; “Heaven”)

In indigenous Chinese religion, the supreme power reigning over humans and lesser gods. The term refers to a deity, to impersonal nature, or to both.
 (2004) on the substitution Substitution
Arsinoë

put her own son in place of Orestes; her son was killed and Orestes was saved. [Gk. Myth.: Zimmerman, 32]

Barabbas

robber freed in Christ’s stead. [N.T.: Matthew 27:15–18; Swed. Lit.
 effect of cash compensation for options. He argues that the value or the incentive effects of an option to executives reduces quickly as more cash pay is substituted for options.

Interestingly but surprisingly and somewhat puzzling puz·zle  
v. puz·zled, puz·zling, puz·zles

v.tr.
1. To baffle or confuse mentally by presenting or being a difficult problem or matter.

2.
, this variable (TCC/S) shows highly significant negative coefficients consistently across all the respective models. This suggests that remunerating top 5 executives with salary and other cash bonuses effectively de-motivates them and thus reduces future performance measures. While we might agree to a reasonable extent with the fact that top corporate executives cannot be effectively motivated by only cash compensation in the glowing era of executive stock options, we would have expected this variable to be insignificant or at best less significant. But the intriguing in·trigue  
n.
1.
a. A secret or underhand scheme; a plot.

b. The practice of or involvement in such schemes.

2. A clandestine love affair.

v.
 thing is that even recent studies in the compensation literature find (what we will call) same anomaly Abnormality or deviation. Pronounced "uh-nom-uh-lee," it is a favorite word among computer people when complex systems produce output that is inexplicable. See software conflict and anomaly detection.  significant negative coefficients (see HRS). Matolcsy (2000) documents what he refers to as "counterintuitive coun·ter·in·tu·i·tive  
adj.
Contrary to what intuition or common sense would indicate: "Scientists made clear what may at first seem counterintuitive, that the capacity to be pleasant toward a fellow creature is ...
 findings", a significant negative relationship between CEO's cash compensation and corporate performance. A completely different interpretation that we can give in this instance is that if a firm uses increasing amount of cash to compensate its top executives, investable cash for worthy positive net present value investment opportunities declines and this could reduce future corporate performance. Future studies that aim at resolving this somewhat counterintuitive finding can be a wonderful contribution to the compensation literature.

The coefficients of the previous performance measures in the respective models exhibit expected pattern or directions, that is, positively related to future performance measures. Findings for the Sumyear +1 +2 and SumYear +1 +2 +3 empirical models are substantially similar with the Year + 1 model (See tables 9 through 12), thus allowing generalization gen·er·al·i·za·tion
n.
1. The act or an instance of generalizing.

2. A principle, a statement, or an idea having general application.
 regarding the three forward-looking models.

Overall, both the lagged model (i.e. 'backward-looking') design and the 'forward-looking' model design findings collectively and consistently provide strong evidence of incentive alignment hypothesis, meaning that it is in the interests of shareholders to remunerate re·mu·ner·ate  
tr.v. re·mu·ner·at·ed, re·mu·ner·at·ing, re·mu·ner·ates
1. To pay (a person) a suitable equivalent in return for goods provided, services rendered, or losses incurred; recompense.

2.
 top corporate executives with executive stock options as this corporate granting behavior strongly motivates executives towards improving future corporate performance, an action that will be in the interest of shareholders. The evidence becomes more compelling as the findings consistently hold if one considers not only reported operating performance measures, but the other measure of earnings believed to reflect the concept of 'true' performance. The latter performance measure is devoid de·void  
adj.
Completely lacking; destitute or empty: a novel devoid of wit and inventiveness.



[Middle English, past participle of devoiden,
 of managers earnings management actions, motivations for which are stronger when there are opportunities to maximize compensation payoffs such as one can find in executive stock options.

Probability of bankruptcy as a proxy for cost of discounting earnings

As explained earlier, the value of the firm can be explained by corporate earnings and the cost of discounting the earnings. While the above analyses, results and discussions center substantially on the earnings components (numerator numerator

the upper part of a fraction.


numerator relationship
see additive genetic relationship.


numerator Epidemiology The upper part of a fraction
) of the concept of the value of the firm, we will be examining the twin of this (denominator denominator

the bottom line of a fraction; the base population on which population rates such as birth and death rates are calculated.

denominator 
) in this section, and this is the cost of discounting the earnings using a measure of the probability of bankruptcy as developed by Altman Z-Score Altman Z-Score

A predictive model created by Edward Altman in the 1960s. This model combines five different financial ratios to determine the likelihood of bankruptcy amongst companies.

Notes:
Generally speaking, the lower the score, the higher the odds of bankruptcy.
 as a proxy (9). We do not use bond rating as a measure of firms' financial soundness for three essential reasons. First, extant research reveals that usually, bonds attract serious analysts' attentions during their first issuance or at infrequent in·fre·quent  
adj.
1. Not occurring regularly; occasional or rare: an infrequent guest.

2.
 extraordinary or special events, and such attentions diminish substantially thereafter (Holthausen and Leftwich, 1986). Second, corroborating this position, Wilson and Fabozzi (1990) provide evidence of the discontinuous discontinuous /dis·con·tin·u·ous/ (dis?kon-tin´u-us)
1. interrupted; intermittent; marked by breaks.

2. discrete; separate.

3. lacking logical order or coherence.
 nature of bond ratings. The final reason is the fact that Howe (1997) notes that there is usually a delay between when the corporate conditions change and when the ratings of the underlying bonds is actually done. Hence, bond ratings may provide a distorting lag that can generate otherwise inappropriate empirical findings to our research question in this instance.

Another potential alternative to the use of accounting-based measures as ingredients in probability of bankruptcy prediction model is stock market information. However, the challenge would be how to extract relevant probability of bankruptcy information from stock prices (see Beaver beaver, either of two large aquatic rodents, Castor fiber and Castor canadensis, known for their engineering feats. They were once widespread in N and central Eurasia except E Siberia, and in North America from the arctic tree line to the S United , 1968; Ohlson, 1980 and Cheung, 1991). This challenge becomes compelling if one considers the fact that the stock market may be inefficiently in·ef·fi·cient  
adj.
1. Not efficient, as:
a. Lacking the ability or skill to perform effectively; incompetent: an inefficient worker.

b.
 positioned (as it is often the case) to incorporate in a timely fashion, all relevant and publicly available information into the security prices (see for example, Sloan, 1996).

The results for the empirical investigation relating to relating to relate prepconcernant

relating to relate prepbezüglich +gen, mit Bezug auf +acc 
 this measure is contained in table 13, where we have the descriptive statistics and correlation matrix coefficients, and table 14 where the regression coefficients are presented. These results are discussed in sequence below.

Descriptive statistics

Here, we present the descriptive statistics of the sample relating the use of executive stock options to remunerate top 5 corporate executives and the probability of corporate failure, as measured by the Altman's Z-Score. In this sample, we have 1,507 firms with firm year observations totaling 8,217. The firms that on the average granted approximately $4.3 million (median $1.7 million) in executive stock options to its top 5 executives, measured by the Black-Scholes option value as reported by the Execucomp data base,, are considered large, profitable and employ sizeable amount of long term debt components in their capital structures, as measured by the size of their assets, earnings per share composition and the leverage status respectively. Large number of firms in the sample also shows promising growth status as measured by the market-to-book value ratio.

On the average, the firms in the sample made approximately $4 billion (median $1.2 billion) in revenue with $3.668 billion (median $1.0 billion) in tangible assets, and carrying long term debt of a little above 30% (median 29%) of their invested capital. On the average, the firms in the sample have approximately 4.79 (median 3.47) Z-Score suggesting a relatively low probability of bankruptcy. According to the bankruptcy prediction model of Atman atman

(Sanskrit: “breath” or “self”) Basic concept in Hindu philosophy, describing that eternal core of the personality that survives death and transmigrates to a new life or is released from the bonds of existence.
 (1968), if the model returns a value less than 1.81, there is a high probability of bankruptcy and if a value greater than 3.0 is produced, then there is low probability of bankruptcy. The values between 1.81 and 3 are in grey areas. The firms in the sample on the average have lower probability of corporate failure.

Regression results of the probability of bankruptcy model

The results for the regression coefficients are presented in table 14. The variables contained in the model are BSO/S, SIZE, TCC/S, ERNVOL, GROWTH and LEV. As was done in the testing of the effect on earnings, we scaled these variables mainly to minimize heteroscedascticity effects on the models as well as allowing for cross-sectional pooling of sampled firms with varying scale levels. The adjusted R-Square of the empirical model is 0.213. The primary variable of interest in the model is the BSO/S and as shown in Table 14, its coefficient is highly significant. This coefficient and its positive sign suggest that a point increase in the use of executive stock options to remunerate top 5 corporate executives leads to 0.046 point increase in the Altman Z-Score statistic, thus implying lower probability of corporate failure. This result corroborates the earnings components results discussed above.

The variable that captures earnings volatility (ERNVOL) appears to support the above comments. This variable has a positive coefficient of 0.032. This coefficient is significant (t-value of 3.04) suggesting that companies with higher earnings volatility have lower probability of corporate failure as a point increase in the volatility measure increases the Z-score by 0.032. However, the relationship between the use of stock options and corporate earnings volatility is worth mentioning. Empirically, there is a positive relationship between the use of this form of compensation package and the measure of earnings volatility. This means that the more the options used to remunerate top 5 corporate executives, the more volatile are corporate earnings.

In other words, granting stock options encourages managers to increase corporate volatility as the value of the options increase, among others, in the volatility of underlying stock returns, implying that stock options presage future volatility. Similarly, larger firms (captured by SIZE) have lower volatile returns and that companies with high volatile earnings are less levered, as such companies may not be attractive debtor-customers to lenders. Also, note that the relationship between the volatility variable and the corporate growth status is positive, suggesting that high growth firms are more likely to experience high earnings volatility. Cui and Mak (2002) document that this category of firms faces substantial operating uncertainty and business risk and that these usually lead in the direction of "significant variation in their profit rate, making accounting figures less informative about managerial performance", all of which will likely translate into corporate volatility.

Notwithstanding Cui and Mark (2002) position, the data here produce empirical results consistent with the original rationale for granting options which is to encourage managers into aggressive but profitable risk-taking behavior. The quality of such risk taking activities of executives (as empirically shown in this paper) is reflected in the fact that the volatility of corporate earnings does not result into increased chances of corporate failure. In fact, it actually reduces it.

Overall, the message here is that granting stock options presages future volatility and thus can increase the potential of corporate failure, consequently leading to high probability of bankruptcy especially in high growth firms with considerable high earnings volatility. We must admit that this conclusion is based on the fact that financial indicators determine corporate chances of bankruptcy. However, research in strategic management and related literature suggests that financially sound and economically worthy corporations can file for bankruptcy for strategic reasons (see for example, Moulton and Thomas, 1993; Shrader and Hickman, 1993; Bell, 1994; Tavakolian, 1995; Daily, 1996; Foust, 2000; Bhattacharya et al, 2007). Rose-Green and Dawkins (2002) distinguish between "financial bankruptcies" and "strategic bankruptcies", claiming that firms in the former categories are more likely to exhibit unimpressive financial indices than firms in the latter group. They conjecture and find that the market reaction to corporate bankruptcy situation discriminates between these two bankruptcy motivations and appropriately penalizes those firms that are compelled into bankruptcy by financial reasons more than those who choose to be strategically 'bankrupt'. Therefore, on the strength of these findings, the rationale for bankruptcy is not a first-order concern for our study as the market appropriately sees through this and reacts accordingly.

Sensitivity Analysis

Robustness checks are conducted to subject the sensitivities of the empirical findings presented and discussed above to alternative scalar scalar, quantity or number possessing only sign and magnitude, e.g., the real numbers (see number), in contrast to vectors and tensors; scalars obey the rules of elementary algebra. Many physical quantities have scalar values, e.g.  choice, intensity of the research and developments expenditure as well as varied sample period. Unreported results indicate that findings are substantially comparable with those of the main analysis.

In order to control for possible firm specific effects, i.e. firm-specific shocks that are constant over time, we run fixed effect regression using the STATA Stata (Statistics/Data Analysis) is a statistical program created in 1985 by Statacorp that is used by many businesses and academic institutions around the world. Most of its users work in research, especially in the fields of economics, sociology, political science, and  statistical software. The magnitudes of the coefficients closely approximate those presented earlier. For example, for the Year + 1 empirical model, the coefficients of the primary variables of interest i.e. BSO/S and [(BSO/S).sup.2] in the new regression are 0.231 and - 0.176 respectively for the reported earnings after controlling for prior performance. These were respectively 0.229 and -0.172 in the main regressions. In both instances, these coefficients are significant at 1% significance level, although the adjusted R-Squared is slightly higher in the fixed effects regression (0.552 as against 0.536).

Further, since almost half of the companies in the Compustat database have missing values In statistics, missing values are a common occurrence. Several statistical methods have been developed to deal with this problem. Missing values mean that no data value is stored for the variable in the current observation.  for R&D, we assign zero to many firms in our sample for the R&D variable. As indicated earlier, this is consistent with the approach maintained in the prior literature. Notwithstanding, we subject our empirical findings to a sensitivity test with regard to R&D variable by considering the research and development-only-firms in order to rule out the possibility that this variable could have driven the empirical results. For the Year + 1 forward-looking model, firm year observations reduces from 8,384 to 4,256 and the number of firms in the sample drops to 874 from 1,666. The coefficients of BSO/S and [(BSO/S).sup.2] in the new regression are 0.329 (0.244) and - 0.254 (-0.143) respectively for the reported earnings (nondiscretionary earnings) after controlling for prior performance. The dollar contributions of the reported earnings (nondiscretionary earnings) are $1.33 ($1.24) albeit an increase over the full sample of $1.23 ($1.15) respectively. These findings suggest a consistent positive contribution pattern in the performance benefits of executive stock option grants.

In addition, in order to address the concerns of potential confounding confounding

when the effects of two, or more, processes on results cannot be separated, the results are said to be confounded, a cause of bias in disease studies.


confounding factor
 effects of the relatively scanty 1992 executive compensation data in our sample since 1992 was the first year Execucomp Database emerges, we remove observations for that year resulting into a shortened sample size. For Year + 1 empirical model, this exercise results into a loss of 250 firm year observations of only seven firms, producing 8,134 instead of 8,384 firm year observations and 1,659 instead of 1,666 firms contained in the full sample. BSO/S and [(BSO/S).sup.2] have coefficients of 0.228 (0.147) and -0.172 (-0.078) respectively for reported earnings (nondiscretionary earnings). The dollar contribution is exactly the same amount with the main analysis, i.e. $1.23 ($1.15).

In order to investigate whether the empirical findings are sensitive to alternative scalar choices, we restate re·state  
tr.v. re·stat·ed, re·stat·ing, re·states
To state again or in a new form. See Synonyms at repeat.



re·state
 the model using current year value of total assets. We consider this analysis worthwhile more importantly because the coefficient of the variable TA/S is consistently negative in virtually all empirical models in the main analyses. Recall that we interpreted this to mean that the variable is actually exhibiting the asset turnover relations in the models, considering the fact that it is scaled with sales. Therefore, in order to further examine this, we scale this variable and other variables in the model by total asset and the coefficient sign of the variable TA/S becomes positive in all the models in addition to the variables of interests displaying consistent coefficients in signs and magnitude. For example, for a Year + 1 model, reported performance (nondiscretionary earnings) after controlling for prior performances produces BSO/S and [(BSO/S).sup.2] equal to 0.201 (0.150) and -0.094 (0.090) respectively.

It must be noted that the pattern of consistent results of the sensitivity analyses with the main analyses holds across the all the empirical models be it 'backward-looking-design or 'forward-looking-design'.

Overall, the theme or tenor of the findings remains substantially unaffected as a result of these sensitivity and additional analyses. Notwithstanding, it is important to mention that like any other research endeavor especially of empirical nature, certain caveats could weaken or impact the conclusions or inferences from the findings of this study. For example, the sample selection criteria may induce survivorship bias Survivorship Bias

Specifically in the context of mutual funds, the tendency for poor performers to drop out while strong performers continue to exist. This results in an overestimation of past returns.
, even though such criteria appear reasonable and acceptable in the domain of empirical accounting research. Also, one cannot completely rule out the potential bias of correlated cor·re·late  
v. cor·re·lat·ed, cor·re·lat·ing, cor·re·lates

v.tr.
1. To put or bring into causal, complementary, parallel, or reciprocal relation.

2.
 omitted variables as it will be extremely difficult, if not impossible to envisage en·vis·age  
tr.v. en·vis·aged, en·vis·ag·ing, en·vis·ag·es
1. To conceive an image or a picture of, especially as a future possibility: envisaged a world at peace.

2.
 and account for all relevant variables in a model. Bearing in mind that it is always tricky Adrian Thaws (born January 27, 1968), better known as Tricky, is an English rapper and musician important in the trip hop and British music scene (despite loathing the "trip hop" tag). He is noted for a whispering lyrical style that is half-rapped, half-sung.  to appropriately foretell fore·tell  
tr.v. fore·told , fore·tell·ing, fore·tells
To tell of or indicate beforehand; predict.



fore·tell
 the direction, level and magnitude of any bias if it exists; noting these caveats is considered appropriate. In addition, we must mention that there is the real concern about the potential problem(s) of endogeneity, and that the tenor of our empirical results may change if appropriate instrumental variables are found in this setting. This is another promising area for future research efforts in this area of compensation research.

Similarly, the total generalizability of this study's findings cannot be guaranteed. This is because, we only consider a somewhat short time-series of new executive stock option grants, spanning only 10 years (i.e. 1992-2001), and performance measures of only 12 years (i.e. 1993-2004) (10). This thus speaks to the generalizability of the empirical findings reported in this study beyond this time frame. Also it should be recalled that this study uses executive stock options value measured by the Black-Scholes option pricing model option pricing model

A mathematical formula for determining the price at which an option should trade. The model expresses the value of an option as a function of the value of the underlying asset, length of time until maturity, exercise price, yields on
. This model is not immune from criticisms among academics, compensation consultants and practitioners alike, as they have consistently pointed to its shortcomings. Therefore, the findings of this study can only be as good as this option pricing model. Finally, there could be measurement error in the variables of choice and this could limit the interpretations of the findings of this study.

Notwithstanding the potential limitations highlighted above, the theme of this study and its findings contribute to the compensation literature and empirical accounting studies in significant dimensions. For example, the findings of this study provide some of the first evidence and probing insights into the option-performance relation within the dynamics of corporate earnings and the cost of discounting such earnings. In this study, we exclude financial firms and other firms in regulated industries. It could be a fruitful fruit·ful  
adj.
1.
a. Producing fruit.

b. Conducive to productivity; causing to bear in abundance: fruitful soil.

2.
 future research effort to examine the option-payoffs relations in these industries. The starting point Noun 1. starting point - earliest limiting point
terminus a quo

commencement, get-go, offset, outset, showtime, starting time, beginning, start, kickoff, first - the time at which something is supposed to begin; "they got an early start"; "she knew from the
 for such studies would be to take care of or control for the peculiarities of these industries vis-a-vis the unique agency relationship and earnings management incentives that subsist sub·sist  
v. sub·sist·ed, sub·sist·ing, sub·sists

v.intr.
1.
a. To exist; be.

b. To remain or continue in existence.

2.
 in them. In addition, given the relatively short sample period of this study, subsequent studies could evaluate the robustness and thus, the generalizability of this study's findings to longer time periods and by extension, larger cross-section of sample firms.

CONCLUSION

Granting stock options is a strategic corporate activity aimed at achieving certain corporate objectives, theoretically in the overall shareholders' ultimate interests. Executive stock options compensation has continued to remain an increasingly substantial component of management compensation packages.

Not many studies have provided direct evidence of the impact of executive stock options on the primary components of firm value which include earnings and cost of discounting the earnings. A notable exception is the study of Hanlon, Rajgopal and Shevlin, 2003 (HRS) which examined the executive stock options vis-a-vis future earnings of the firm. However, our findings extend HRS findings by showing in part that nondiscretionary measure could be a more appropriate guide to compensation committees and corporate boards when making executive compensation decisions. In fact, our findings could have potential public policy implications and ramifications ramifications nplAuswirkungen pl  giving the contemporariness of executive compensations in the debates surrounding sur·round  
tr.v. sur·round·ed, sur·round·ing, sur·rounds
1. To extend on all sides of simultaneously; encircle.

2. To enclose or confine on all sides so as to bar escape or outside communication.

n.
 current global economic turmoil. Generally, studies on employees/executive stock options appear to assume that the value of the firm is impacted by the use of this compensation package and thus build the focus of their investigations on this premise (see for example Akindayomi, 2010 for a review of relevant literature). While such an assumption could be well placed, it is yet sufficiently unclear which component of the firm value is individually or jointly impacted by the use of stock options to compensate executives. Therefore, this study is motivated by the need to fill this important gap (and generally the taken-for-granted view) in the literature, with the intent to examining the impact of granting options to top corporate executives on the firms' earnings, cost of capital and by extension the value of the firm.

The concept of accounting earnings and the cost of discounting such earnings are central to the value of the firm. Theoretically, therefore, the effect of using stock options to compensate executives should be reflected in those two major components of the firm value i.e. the earnings component and the cost of capital or discount rate associated with the earnings. Thus, central to this study is the firms' cost of discounting earnings, as well as the various measures of earnings. The volatility of the firm's earnings and the probability of bankruptcy are used to capture the responsiveness of the firm's cost of capital to the use of stock options to compensating top executives, while the measures of earnings employed are the reported operating earnings and 'nondiscretionary' earnings. Overall, both the lagged model (i.e. 'backward-looking') design and the 'forward-looking' model design findings collectively and consistently provide strong evidence of incentive alignment hypothesis, meaning that it is in the interests of shareholders to remunerate top corporate executives with executive stock options as this corporate granting behavior strongly motivates executives towards improving future corporate performance, an action that will be in the interest of shareholders. The evidence becomes more compelling as the findings consistently hold if one considers not only reported operating performance measures, but the other measure of the earnings believed to reflect the concept of 'true' performance as such a performance measure is devoid of managers earnings management actions, motivations for which are stronger when there are opportunities to maximize compensation payoffs like one can find in executive stock options. In other words, we could not find support for the competing rent extraction hypothesis, as executive stock option grants improve future corporate performance as measured by the earnings measures.

Corroboratively, the empirical findings in relation to the proxy of cost of discounting earnings as measured by the Altman Z-Score statistic of bankruptcy probability also reinforce the earnings components findings, even as volatility increases in executive stock option grants.

ACKNOWLEDGEMENTS

The authors acknowledge helpful comments by Amin Mawani and Steven Balsam on the earlier version of this paper, as well as feedback by colleagues in University of Calgary and University of Texas - Pan American, the participants of the AAA Southeastern 2008 meeting in Birmingham, Alabama Birmingham (pronounced [ˈbɝmɪŋˌhæm]) is the largest city in the U.S. state of Alabama and is the county seat of Jefferson County. , and the participants of Canadian Canadian (kənā`dēən), river, 906 mi (1,458 km) long, rising in NE New Mexico. and flowing E across N Texas and central Oklahoma into the Arkansas River in E Oklahoma.  Academic Accounting Association (CAAA) 2009 meeting in Montreal. This paper was nominated nom·i·nate  
tr.v. nom·i·nat·ed, nom·i·nat·ing, nom·i·nates
1. To propose by name as a candidate, especially for election.

2. To designate or appoint to an office, responsibility, or honor.
 for best paper award in the AAA Southeastern 2008 meeting in Birmingham, Alabama. It then received the "Distinguished Research Award" from the Academy of Accounting and Financial Studies. Akindayomi A, also likes to thank members of his dissertation dis·ser·ta·tion  
n.
A lengthy, formal treatise, especially one written by a candidate for the doctoral degree at a university; a thesis.


dissertation
Noun

1.
 committee as this piece is a part-product of his doctoral dissertation at University of Calgary. The authors will also like to acknowledge the research grant by the CGA Alberta Faculty Fellowship fellowship Graduate education A post-residency training period of 1–2 yrs in a subspecialty–eg, hand surgery, which allows a specialized physician to develop a particular expertise that may have a related subspecialty board; fellowship time is often .

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Tian, Y. S. (2004). Too much of a good incentive? The case of executive stock options. Journal of Banking and Finance, 28(6), 1225-1245.

Titman, S. & R. Wessels. (1988). The determinants of capital structure choice. Journal of Finance, 43 (1), 1-19.

Wilson, R. & F. Fabozzi (1990). The New corporate bond market. Chicago, IL:

Zaretzky, K. & J. K. Zumwalt (2007). Relation between distress risk, book-to-market ratio Book-To-Market Ratio

A ratio used to find the value of a company by comparing the book value of a firm to its market value. Book value is calculated by looking at the firm's historical cost, or accounting value.
 and return premium. Managerial Finance Managerial finance is the branch of finance that concerns itself with the managerial significance of finance techniques. It is focused on assessment rather than technique. , 3(10), 788-97.

Akinloye Akindayomi, University of Texas-Pan American

Hussein A. Warsame, University of Calgary

ENDNOTES

(1.) Our assertion is informed by the fact that many firms that participate in TARP have been under intense scrutiny of the regulators and the congress such that the congress insists that the firms must pay back their TARP obligations before paying out the usual big cash compensation to executives. For more on TARP, see the Emergency Economic Stabilization Stabilization

The action undertakes a country when it buys and sells its own currency to protect its exchange value.
Actions registered competitive traders undertake by on the NYSE to meet the exchange requirement that 75% of their traded be stabilizing, meaning that sell orders
 Act of 2008, and Public Law 110-343.

(2.) Value of the firm can be demonstrated using the framework of firm valuation model as developed by the Feltham-Ohlson, 1995 (hereinafter here·in·af·ter  
adv.
In a following part of this document, statement, or book.


hereinafter
Adverb

Formal or law from this point on in this document, matter, or case

Adv. 1.
 referred to as FO).

[P.sub.t] = [bv.sub.t] + [[infinity infinity, in mathematics, that which is not finite. A sequence of numbers, a1, a2, a3, … , is said to "approach infinity" if the numbers eventually become arbitrarily large, i.e. ].summation summation n. the final argument of an attorney at the close of a trial in which he/she attempts to convince the judge and/or jury of the virtues of the client's case. (See: closing argument)  over ([tau]=1)][R.sup.-[tau].sub.f][E.sub.t][[x.sup.a.sub.t+[tau]]]

Where:

[P.sub.t] = market value of the firm's equity, at time t

[bv.sub.t] = book value of the firm's equity at time t

[R.sub.f] = the firm's cost of capital or the discounting rate of the earnings. FO suggests that [R.sub.f] be calculated as one plus the risk-free interest rate Risk-Free Interest Rate

Describes return available to an investor in a security somehow guaranteed to produce that return. The risk-free interest rate compensataes the investor for the temporary sacrifice of consumption.
.

[x.sup.a] = the abnormal earnings; Et = the expectation operator

(3.) Clement et al (2003) used a variation of the firm valuation model viz: [P.sub.t] = k x [[infinity].summation over (t=1)][E.sub.t]/[(1+r).sup.[tau]]. However, one of the implicit inferences in FO framework is that in order to determine the value of the firm, one does not necessarily have to forecast future dividends, a view Bernard (1995) applauds and describes as taking accounting researcher's away from the "traditional mainstream view"; notwithstanding, some researchers still use it as a starting point in evaluating the effect of the primary components of the firm values viz earnings and cost of capital which are still relevant even in the FO framework. But in order to reflect the distinctive relevance of accounting numbers to the value of the firm, this study will align align (līn),
v to move the teeth into their proper positions to conform to the line of occlusion.
 with the conceptual inferences of the FO valuation model.

(4.) For example, DeFond and Hung (2003) identify cash flow forecasts as one of the information sources that have to be released to the market by firms with high volatile earnings so that "market participants could identify the persistent components in earnings."

(5.) The discrepancies in the number of firms and firm-years between and within the backward and forward Adv. 1. backward and forward - moving from one place to another and back again; "he traveled back and forth between Los Angeles and New York"; "the treetops whipped to and fro in a frightening manner"; "the old man just sat on the porch and rocked back and forth all  looking models are mainly due to the stronger data requirement constraints CONSTRAINTS - A language for solving constraints using value inference.

["CONSTRAINTS: A Language for Expressing Almost-Hierarchical Descriptions", G.J. Sussman et al, Artif Intell 14(1):1-39 (Aug 1980)].
 imposed by their underlying characteristics, as the final sample in each of these categories contains only firms and firm-year observations with required compensation and financial data. Also note that we use firm-years and not firm-quarters or other potentially usable periods because the Execucomp which is the source of our stock options data is available on annual basis.

(6.) We must admit that the lagged design results presented above are effectively challenged by Larcker's observations on the research design choice. We therefore, re-examine the research question using the 'forward-looking' design below.

(7.) For more on this, see our discussions surrounding this relation in the section on the lagged results above.

(8.) Instead, they do so as part of their sensitivity analysis, while they mention that their results remain qualitatively similar, we strongly believe, that the performance contribution attributed to executive stock options in their baseline model might be somehow overstated o·ver·state  
tr.v. o·ver·stat·ed, o·ver·stat·ing, o·ver·states
To state in exaggerated terms. See Synonyms at exaggerate.



o
.

(9.) For example, Chen and Wei (1993) documented that firms with less likelihood of becoming bankrupt (i.e. with lower probability of bankruptcy) are more likely to enjoy waiver The voluntary surrender of a known right; conduct supporting an inference that a particular right has been relinquished.

The term waiver is used in many legal contexts.
 opportunity from creditors. This suggests that the cost of debt and by extension the cost of operations of such firms is likely to be lower relative to firms with high probability of bankruptcy.

(10.) HRS considered an eight-year and a three-year of time-series of option grants and payoffs relations respectively.
TABLE 1: {BACKWARD LOOKING DESIGN}
DESCRIPTIVE STATISTICS AND CORRELATION MATRIX

Panel A: Descriptive Statistics

                         N = 2,579: F = 858

Variables               Mean      Std.     Median    Q1     Q3
                                deviation

OPINC ($billion)        0.845     2.028    0.239   0.091   0.717
NDE ($billion)          0.322     1.009    0.082   0.024   0.259
SALES ($billion)        5.395    11.151    1.737   0.730   4.977
BSO grants (Smillion)   7.758    18.819    2.684   0.865   7.512
ASSETS ($billion)       5.050    12.382    1.564   0.654   4.611
OPINC/S                 0.149     0.206    0.140   0.087   0.206
NDE/S                   0.070     0.190    0.060   0.020   0.110
TA/S                    1.083     0.794    0.887   0.621   1.281
BSO/S                   0.004     0.009    0.001   0.0005  0.003
R&D/S                   0.043     0.181    0.004   0.000   0.037

Panel B: Correlation Matrix

Variables              OPINC/S    NDE/S     TA/S   BSO/S   R&D/S

OPINC/S                   1
NDE/S                   0.435       1
TA/S                    0.343     0.290      1
BSO/S                   0.303     0.514    0.382     1
R&D/S                   0.202     0.536    0.522   0.491     1

Note on Panel A:

The 'backward-looking' design model is estimated using 2,579 firm-year
observations for a total of858 firms with no missing data. The firm y
span through 1998 to 2001. OPINC is annual operating income; NDE is
nondiscretionary earnings; Sales is annual sales, BSO is Black-Sch
value of options grants to top 5 corporate executives as per Execucomp,
ASSETS is year-end balance sheet value of total assets (TA) and R&D is
research and development expenditure. Missing values of R&D are set to
zero.

Note on Panel B:

Variables are as described above scaled by sales. All correlations are
significant at conventional thresholds except otherwise indicated
superscript NS

TABLE 2: {FORWARD LOOKING DESIGN} {YEAR + 1}
DESCRIPTIVE STATISTICS AND CORRELATION MATRIX

Panel A: Descriptive Statistics

                            N = 8,384: F = 1,666

Variables                Mean       Std.      Median     Q1      Q3
                                  deviation

OPINC (Sbillion)         0.611      1.650     0.160    0.058    0.467
NDE (Sbillion)           0.236      0.872     0.034    -0.007   0.167
SALES (Sbillion)         4.089     10.057     1.216    0.494    3.497
BSO grants (Smillion)    4.428     11.171     1.673    0.645    4.263
ASSETS (Sbillion)        3.805     10.983     0.991    0.384    2.952
OPINC/S                  0.150      0.148     0.140    0.080    0.020
NDE/S                    0.020      0.145     0.030    -0.010   0.070
TA/S                     1.010      0.921     0.820    0.590    1.180
BSO/S                    0.003      0.004     0.001    0.0004   0.004
R&D/S                    0.030      0.071     0.001    0.000    0.033

Panel B: Correlation Matrix

Variables               OPINC/S     NDE/S      TA/S    BSO/S    TCC/S

OPINC/S                    1
NDE/S                    0.670        1
TA/S                     0.117     -0.120       1
BSO/S                    0.201      0.065     0.190      1
TCC/S                   0.020NS    -0.320     0.301    0.434      1
R&D/S                    0.256      0.196     0.279    0.360    0.375

Panel A: Descriptive Statistics

N = 8,384: F = 1,666

Variables

OPINC (Sbillion)
NDE (Sbillion)
SALES (Sbillion)
BSO grants (Smillion)
ASSETS (Sbillion)
OPINC/S
NDE/S
TA/S
BSO/S
R&D/S

Panel B: Correlation Matrix

Variables               R&D/S

OPINC/S
NDE/S
TA/S
BSO/S
TCC/S
R&D/S                     1

Note on Panel A:

The 'forward-looking' design model {Year + 1} is estimated using 8,384
firm-year observations for a total of 1,666 firms with no missing data
Firm years span through 1992 to 2001. OPINC is annual operating income
following the year of grant; NDE is nondiscretionary earnings following
the year of grant; following the year ofgrant, Sales is annual sales,
BSO is Black-Scholes value of options grants to top 5 corporate
executives as per Execucomp, ASSETS is year-end balance sheet value of
total assets (TA), TCC is cash compensation for top 5 corporate
executives as per Execucomp, and R&D is research and development
expenditure. Missing values of R&D are set to zero.

Note on Panel B:

Variables are as described above scaled by sales. All correlations are
significant at conventional thresholds except otherwise indicated as a
superscript NS.

TABLE 3: {FORWARD LOOKING DESIGN}
{SUMYEAR + 1 + 2}
DESCRIPTIVE STATISTICS AND CORRELATION MATRIX

Panel A: Descriptive Statistics

                            N = 6,666: F = 1,476

Variables                 Mean       Std.      Median     Q1      Q3
                                   deviation

OPINC1 ($billion)        1.335       3.554     0.357    0.135    1.050
NDE1 ($billion)          0.516       1.754     0.078    -0.013   0.367
SALES ($billion)         9.034      22.517     2.707    1.089    7.720
BSO grants ($million)    4.687      10.677     1.811    0.703    4.564
ASSETS ($billion)        3.984      11.302     1.020    0.401    3.165
OPINC1/S                 0.150       0.121     0.140    0.090    0.020
NDE1/S                   0.020       0.112     0.030    -0.010   0.070
TA/S                     0.480       0.393     0.390    0.280    0.560
BSO/S                    0.002       0.004     0.001    0.0002   0.002
R&D/S                    0.009       0.014     0.002    0.000    0.014

Panel B: Correlation Matrix

Variables               OPINC1/S    NDE1/S      TA/S    BSO/S    TCC/S

OPINC1/S                   1
NDE1/S                   0.662         1
TA/S                     0.225      -0.065       1
BSO/S                    0.121      -0.059     0.154      1
TCC/S                    0.060      -0.351     0.213    0.442      1
R&D/S                    0.356       0.312     0.036    0.204    0.175

Panel A: Descriptive Statistics

N = 6,666: F = 1,476

Variables

OPINC1 ($billion)
NDE1 ($billion)
SALES ($billion)
BSO grants ($million)
ASSETS ($billion)
OPINC1/S
NDE1/S
TA/S
BSO/S
R&D/S

Panel B: Correlation Matrix

Variables               R&D/S

OPINC1/S
NDE1/S
TA/S
BSO/S
TCC/S
R&D/S                     1

Note on Panel A:

The 'forward-looking' design model {SumYear + 1 + 2} is estimated
using 6,666 firm-year observations for a total of 1,476 firms with no
missing data. Firm years span through 1992 to 2001. OPINC1 is sum of
operating income for two years following the grant year; NDE1 is sum
of nondiscretionary earnings for two years following the grant year;
Sales is annual sales, BSO is Black-Scholes value of options grants
to top 5 corporate executives as per Execucomp, ASSETS is year-end
balance sheet value of total assets (TA), TCC is cash compensation for
top 5 corporate executives as per Execucomp, and R&D is research and
development expenditure. Missing values of R&D are set to zero.

Note on Panel B:

Variables are as described above scaled by sales. All correlations are
significant at conventional thresholds except otherwise indicated as a
superscript NS.

TABLE 4: {FORWARD LOOKING DESIGN}
{SUMYEAR + 1 + 2 + 3}
DESCRIPTIVE STATISTICS AND CORRELATION MATRIX

Panel A: Descriptive Statistics

                       N = 5,357: F = 1,283

Variables                 Mean       Std.       Median       Q1
                                   deviation

OPINC2S ($billion)       2.061       5.402       0.546     0.197
NDE2 ($billion)          0.840       2.711       0.128     -0.021
SALES ($billion)         12.866     29.887       3.943     1.587
BSO grants ($million)    5.065      12.627       1.587     0.748
ASSETS ($billion)        3.660       8.358       1.015     0.396
OPINC22/S                0.150       0.099       0.140     0.100
NDE2/S                   0.020       0.116       0.030     -0.010
TA/S                     0.285       0.107       0.267     0.199
BSO/S                    0.001       0.004       0.000     0.0002
R&D/S                    0.010       0.013       0.004     0.000

Panel B: Correlation Matrix

Variables               OPINC2/S    NDE2/S       TA/S      BSO/S

OPINC2/S                   1
NDE2/S                   0.709         1
TA/S                     0.275       0.074         1
BSO/S                    0.152     -0.004 NS     0.140       1
TCC/S                    0.078      -0.408       0.137     0.364
R&D/S                    0.489       0.367       0.293     0.237

Panel A: Descriptive Statistics

    N = 5,357: F = 1,283

Variables                 Q3

OPINC2S ($billion)      1.587
NDE2 ($billion)         0.607
SALES ($billion)        11.265
BSO grants ($million)   4.727
ASSETS ($billion)       2.993
OPINC22/S               0.200
NDE2/S                  0.070
TA/S                    0.353
BSO/S                   0.001
R&D/S                   0.014

Panel B: Correlation Matrix

Variables               TCC/S    R&D/S

OPINC2/S
NDE2/S
TA/S
BSO/S
TCC/S                     1
R&D/S                   0.257      1

Note on Panel A:

The 'forward-looking' design model {SumYear + 1 + 2 + 3} is estimated
using 5,357firm-year observations for a total of 1,283 firms with no
missing data. Firm years span through 1992 to 2001. OPINC2 is sum of
operating income for three years following the grant year; NDE2 is sum
of nondiscretionary earnings for three years following the grant year;
Sales is annual sales, BSO is Black-Scholes value of options grants to
top 5 corporate executives as per Execucomp, ASSETS is year-end balance
sheet value of total assets (TA) and R&D is research and development
expenditure. Missing values of R&D are set to zero.

Note on Panel B:

Variables are as described above scaled by sales. All correlations are
significant at conventional thresholds except otherwise indicated as a
superscript NS.

TABLE 5: {BACKWARD LOOKING DESIGN}
ESTIMATION OF PAYOFFS USING BLACK-SCHOLES VALUES OF BSO GRANTS
{N= 2,579; F= 858}

Panel A: {Regression Coefficients}

                                    LINEAR

                                       1             2

Variable {Dependent: OPINC/S}     Coefficient   Coefficient

TA/S 5                             0.07 ***     -0.127 ***
[5.summation over (k=0)]           0.191 ***     0.218 ***
  [[alpha].sub.2,k]
  [(BSO/S).sub.i,t-k]
[5.summation over (k=0)]
  [[alpha].sub.3,k]
  [(BSO/S).sup.2.sub.i,t-k]
[5.summation over (k=0)]          -0.091 ***    -0.137 ***
  [[alpha].sub.4,k]
  [(R&D/S).sub.i,t-k]
[sigma][(OPINC/S).sub.it-1]          0.034       0.088 ***
[(OPINC).sub.t-1]/S                              0.634 ***
Adj. [R.sup.2] without dummies       0.274         0.49
Adj. [R.sup.2] overall               0.448         0.574

{N= 2,579; F= 858}

Panel A: {Regression Coefficients}

                                                 NONLINEAR

                                       3             4

Variable {Dependent: OPINC/S}     Coefficient   Coefficient

TA/S 5                             0.094 ***    -0.113 ***
[5.summation over (k=0)]           0.348 ***     0.408 ***
  [[alpha].sub.2,k]
  [(BSO/S).sub.i,t-k]
[5.summation over (k=0)]          -0.171 ***    -0.115 ***
  [[alpha].sub.3,k]
  [(BSO/S).sup.2.sub.i,t-k]
[5.summation over (k=0)]           0.067 ***     -0.07 ***
  [[alpha].sub.4,k]
  [(R&D/S).sub.i,t-k]
[sigma][(OPINC/S).sub.it-1]         -0.032       0.06 ***
[(OPINC).sub.t-1]/S                              0.627 ***
Adj. [R.sup.2] without dummies       0.326         0.513
Adj. [R.sup.2] overall               0.475         0.59

Panel B: Economic effects sensitivity of various BSO distribution
{without previous performance}

                                 LINEAR

                      BSO/S    Effect on     Implied
Distribution Cutoff             OPINC/S    Sensitivity

FIRST                 0.0005    0.0001        0.19
MEDIAN                0.0012    0.0002        0.19
THIRD                 0.0033    0.0006

                                NONLINEAR

                      BSO/S    Effect on     Implied
Distribution Cutoff             OPINC/S    Sensitivity

FIRST                 0.0005    0.0002        0.35
MEDIAN                0.0012    0.0004        0.35
THIRD                 0.0033    0.0012

Panel C: Economic effects sensitivity of various BSO distribution
{with previous performance}

                                 LINEAR

Distribution Cutoff   BSO/S    Effect on     Implied
                                OPINC/S    Sensitivity

FIRST                 0.0005    0.0001        0.22
MEDIAN                0.0012    0.0003        0.22
THIRD                 0.0033    0.0007

                               NONLINEAR

Distribution Cutoff   BSO/S    Effect on     Implied
                                OPINC/S    Sensitivity

FIRST                 0.0005    0.0002        0.41
MEDIAN                0.0012    0.0005        0.41
THIRD                 0.0033    0.0014

Note on Panel A:

***, ** and * represent significance levels at 0.01, 0.05 and 0.10
respectively.

The 'backward-looking' design model is estimated using 2,579 firm-year
observations for a total of 858 firms with no missing data. The firm
years span through 1998 to 2001. OPINC is annual operating income;
Sales is annual sales, BSO is Black-Scholes value of options grants
to top 5 corporate executives as per Execucomp, ASSETS is year-end
balance sheet value of total assets (TA) and R&D is research and
development expenditure. Missing values of R&D are set to zero. All
variables are scaled by sales. Years are indexed by t and firms by i,
time and industry dummies are suppressed for expositional convenience.
Panel A contains regression coefficient estimates. Columns 1 and 3
contain coefficients without previous performance while columns 2 and
4 cover estimates with previous performance. Columns 1 to 2 and
columns 3 to 4 are for linear and nonlinear models respectively.

Note on Panel B and C:

Implied sensitivity analyses in panel B and C refer to the change
in OPINC/S scaled by change in BSO/S.

TABLE 6: {BACKWARD LOOKING DESIGN}
ESTIMATION OF PAYOFFS USING BLACK-SCHOLES VALUES OF BSO GRANTS
{N= 2,579; F = 858}

Panel A: {Regression Coefficients}

                                        LINEAR              NONLINEAR

                                    1             2             3

Variable {Dependent: NDE/S}    Coefficient   Coefficient   Coefficient

TA/S 5                         -0.181 ***    -0.084 ***    -0.136 ***
[5.summation over (k=0)]        0.288 ***     0.128 ***     0.317 ***
  [[alpha].sub.2,k]
  [(BSO/S).sub.i,t-k]

[5.summation over (k=0)]                                   -0.187 ***
  [[alpha].sub.3,k]
  [(BSO/S).sup.2.sub.i,t-k]

[5.summation over (k=0)]        0.171 ***    -0.017 ***     0.363 ***
  [[alpha].sub.4,k]
  [(BSO/S).sub.i,t-k]

[sigma][(NDE/S).sub.it-1]       0.523 ***    -0.281 ***     0.266 ***

[(NDE).sub.t-1]/S                             1.091 ***

Adj. [R.sup.2] without            0.697         0.781         0.733
  dummies

Adj. [R.sup.2] overall            0.730         0.794         0.756

Panel A: {Regression Coefficients}

                                NONLINEAR

                                    4

Variable {Dependent: NDE/S}    Coefficient

TA/S 5                         -0.072 ***
[5.summation over (k=0)]        0.213 ***
  [[alpha].sub.2,k]
  [(BSO/S).sub.i,t-k]

[5.summation over (k=0)]       -0.042 ***
  [[alpha].sub.3,k]
  [(BSO/S).sup.2.sub.i,t-k]

[5.summation over (k=0)]        0.104 ***
  [[alpha].sub.4,k]
  [(BSO/S).sub.i,t-k]

[sigma][(NDE/S).sub.it-1]       0.325 ***

[(NDE).sub.t-1]/S               0.993 ***

Adj. [R.sup.2] without            0.794
  dummies

Adj. [R.sup.2] overall            0.804

Panel B: Economic effects sensitivity of various BSO distribution
{without previous performance}

                                LINEAR

Distribution Cutoff   BSO/S    Effect on     Implied
                                 NDE/S     Sensitivity

FIRST                 0.0005    0.0001        0.29
MEDIAN                0.0012    0.0004        0.29
THIRD                 0.0033    0.0033

                               NONLINEAR

Distribution Cutoff   BSO/S    Effect on     Implied
                                 NDE/S     Sensitivity

FIRST                 0.0005    0.0002        0.32
MEDIAN                0.0012    0.0004        0.32
THIRD                 0.0033    0.0010

Panel C: Economic effects sensitivity of various BSO distribution
{with previous performance}

                                 LINEAR

Distribution Cutoff   BSO/S    Effect on     Implied
                                 NDE/S     Sensitivity

FIRST                 0.0005    0.0001        0.13
MEDIAN                0.0012    0.0002        0.13
THIRD                 0.0033    0.0004

                               NONLINEAR

Distribution Cutoff   BSO/S    Effect on     Implied
                                 NDE/S     Sensitivity

FIRST                 0.0005    0.0001
MEDIAN                0.0012    0.0003
THIRD                 0.0033    0.0007

Note on Panel A:

***, ** and * represent significance levels at 0.01, 0.05 and 0.10
respectively.

The 'backward-looking' design model is estimated using 2,579 firm-year
observations for a total of 858 firms with no missing data. The firm
years span through 1998 to 2001. NDE is nondiscretionary earnings;
Sales is annual sales, BSO is Black-Scholes value of options grants to
top 5 corporate executives as per Execucomp, ASSETS is year-end
balance sheet value of total assets (TA) and R&D is research and
development expenditure. Missing values of R&D are set to zero. All
variables are scaled by sales. Years are indexed by t and firms by i,
time and industry dummies are suppressed for expositional convenience.
Panel A contains regression coefficient estimates. Columns 1 and 3
contain coefficients without previous performance while columns 2 and
4 cover estimates with previous performance. Columns 1 to 2 and
columns 3 to 4 are for linear and nonlinear models
respectively.

Note on Panel B and C:

Implied sensitivity analyses in panel B and C refer to the change in
NDE/S scaled by change in BSO/S.

TABLE 7: {FORWARD LOOKING DESIGN}
{YEAR + 1}
ESTIMATION OF PAYOFFS USING BLACK-SCHOLES VALUES OF BSO GRANTS
{N= 8,384; F= 1,666}

Panel A: {Regression Coefficients without Previous Performance}

                                      1              2           3

Variable {Dependent: OPINC/S}    Coefficients   t-statistic   p-value

TA/S                                -0.138        -12.28       .000
BSO/S                               0.131          12.18       .000
[(BSO/S).sup.2]
RD/S                                0.243          21.28       .000
TCC/S                               -0.170        -15.63       .000
Adj. [R.sup.2] without dummies      0.100
Adj. [R.sup.2] overall              0.316

Panel A: {Regression Coefficients without Previous Performance}

                                      4              5          6

Variable {Dependent: OPINC/S}    Coefficients   t-statistic   value

TA/S                                -0.136        -12.21      .000
BSO/S                               0.373          13.39      .000
[(BSO/S).sup.2]                     -0.249         -9.40      .000
RD/S                                0.252          22.07      .000
TCC/S                               -0.179        -16.47      .000
Adj. [R.sup.2] without dummies      0.115
Adj. [R.sup.2] overall              0.323

Panel B: {with previous performance}

TA/S                              -0.152     -16.35      .000
BSO/S                             0.062       6.90       .000
[(BSO/S).sup.2]
RD/S                              0.065       6.57       .000
TCC/S                             -0.059     -6.40       .000
[(OPINC).sub.t-1]/S               0.567      62.08       .000
Adj. [R.sup.2] without dummies    0.478
Adj. [R.sup.2] overall            0.533

TA/S                              -0.151     -16.28      .000
BSO/S                             0.229       9.90       .000
[(BSO/S).sup.2]                   -0.172     -7.83       .000
RD/S                              0.072       7.29       .000
TCC/S                             -0.066     -7.15       .000
[(OPINC).sub.t-1]/S               0.563      61.76       .000
Adj. [R.sup.2] without dummies    0.483
Adj. [R.sup.2] overall            0.536

Panel C: Economic effects sensitivity of various BSO distribution
{without previous performance}

                         LINEAR                     NONLINEAR

Distribution   BSO/S    Effect on     Implied              Effect on
Cutoff                   OPINC/S    Sensitivity   BSO/S     OPINC/S

FIRST          0.0004    0.0001        0.13       0.0004    0.0002
MEDIAN         0.0012    0.0002        0.13       0.0012    0.0004
THIRD          0.0035    0.0005                   0.0035    0.0013

                NONLINEAR

Distribution     Implied
Cutoff         Sensitivity

FIRST             0.37
MEDIAN            0.37
THIRD

Panel D: Economic effects sensitivity of various BSO distribution
{with previous performance}

                         LINEAR                      NONLINEAR

Distribution   BSO/S    Effect on     Implied     BSO/S    Effect on
Cutoff                   OPIN/S     Sensitivity             OPINC/S

FIRST          0.0004    0.0000        0.06       0.0004    0.0001
MEDIAN         0.0012    0.0001        0.06       0.0012    0.0003
THIRD          0.0035    0.0002                   0.0035    0.0008

               NONLINEAR

Distribution     Implied
Cutoff         Sensitivity

FIRST             0.23
MEDIAN            0.23
THIRD

Notes on Panels A & B:

The 'forward-looking' design model {Year + 1} is estimated using 8,384
firm-year observations for a total of 1,666 firms with no missing data.
Firm years span through 1992 to 2001. OPINC is annual operating income
following the year of grant {the dependent measure}; Sales is annual
sales, BSO is Black-Scholes value of options grants to top 5 corporate
executives as per Execucomp, ASSETS is year-end balance sheet value of
total assets (TA), TCC is cash compensation for top 5 corporate
executives as per Execucomp and R&D is research and development
expenditure. Missing values of R&D are set to zero. All variables are
scaled by sales. Years are indexed by t and firms by i, time and
industry dummies are suppressed for expositional convenience. Panel A
is with respect to estimates without previous performance while Panel
B covers estimates with previous performance. Columns 1 to 3 and
columns 4 to 6 are for linear and nonlinear models respectively in
both panels.

Note on Panel C and D:

Implied sensitivity analyses in panel C and D refer to the change
in OPINC/S scaled by change in BSO/S.

TABLE 8: {FORWARD LOOKING DESIGN} {YEAR + 1}
ESTIMATION OF PAYOFFS USING BLACK-SCHOLES VALUES OF BSO GRANTS
{N= 8,384; F = 1,666}

Panel A: {Regression Coefficients without Previous Performance}

                               1              2             3

Variable                  Coefficients   t-statistic     p-value
{Dependent: NDE/S}

TA/S                         -0.188        -16.81         .000
BSO/S                        0.128          11.91         .000
[(BSO/S).sup.2]
RD/S                         0.310          27.26         .000
TCC/S                        -0.500        -46.14         .000
Adj. [R.sup.2] without       0.250
  dummies
Adj. [R.sup.2] overall       0.324

                               4              5             6

Variable                  Coefficients   t-statistic     p-value
{Dependent: NDE/S}

TA/S                         -0.187        -16.76         .000
BSO/S                        0.247          8.90          .000
[(BSO/S).sup.2]              -0.124         -4.67         .000
RD/S                         0.314          27.57         .000
TCC/S                        -0.504        -46.43         .000
Adj. [R.sup.2] without       0.256
  dummies
Adj. [R.sup.2] overall       0.325

Panel B: {with previous performance}

                               1              2             3

Variable                  Coefficients   t-statistic     p-value
{Dependent: NDE/S}

TA/S                         -0.072         -7.49         .000
BSO/S                        0.072          7.86          .000
[(BSO/S).sup.2]
RD/S                         0.058          5.44          .000
TCC/S                        -0.254        -25.07         .000
(NDE)t-1/S                   0.543          57.27         .000
Adj. [R.sup.2] without       0.498
  dummies
Adj. [R.sup.2] overall       0.515

                               4              5             6

Variable                  Coefficients   t-statistic     p-value
{Dependent: NDE/S}

TA/S                         -0.072         -7.47         .000
BSO/S                        0.147          6.22          .000
[(BSO/S).sup.2]              -0.078         -3.45         .001
RD/S                         0.061          5.72          .000
TCC/S                        -0.257        -25.30         .000
(NDE)t-1/S                   0.541          57.15         .000
Adj. [R.sup.2] without       0.500
  dummies
Adj. [R.sup.2] overall       0.516

Panel C: Economic effects sensitivity of various BSO distribution
{without previous performance}

                                           LINEAR

Distribution Cutoff          BSO/S        Effect on      Implied
                                            NDE/S      Sensitivity

FIRST                        0.0004        0.0001         0.13
MEDIAN                       0.0012        0.0002         0.13
THIRD                        0.0035        0.0004

                                          NONLINEAR

Distribution Cutoff          BSO/S        Effect on      Implied
                                            NDE/S      Sensitivity

FIRST                        0.0004        0.0001         0.25
MEDIAN                       0.0012        0.0003         0.25
THIRD                        0.0035        0.0009

Panel D: Economic effects sensitivity of various BSO distribution {with
previous performance}

                                           LINEAR

Distribution Cutoff          BSO/S        Effect on      Implied
                                            NDE/S      Sensitivity

FIRST                        0.0004        0.0000         0.07
MEDIAN                       0.0012        0.0001         0.07
THIRD                        0.0035        0.0002

                                          NONLINEAR

Distribution Cutoff          BSO/S        Effect on      Implied
                                            NDE/S      Sensitivity

FIRST                        0.0004        0.0001         0.15
MEDIAN                       0.0012        0.0002         0.15
THIRD                        0.0035        0.0005

Notes on Panels A & B:

The 'forward-looking' design model {Year + 1} is estimated using 8,384
firm-year observations for a total of 1,666 firms with no missing data.
Firm years span through 1992 to 2001. NDE is nondiscretionary earnings
following the year of grant {the dependent measure}; Sales is annual
sales, BSO is Black-Scholes value of options grants to top 5 corporate
executives as per Execucomp, ASSETS is year-end balance sheet value of
total assets (TA), TCC is cash compensation for top 5 corporate
executives as per Execucomp and R&D is research and development
expenditure. Missing values of R&D are set to zero. All variables are
scaled by sales. Years are indexed by t and firms by i, time and
industry dummies are suppressed for expositional convenience. Panel A
is with respect to estimates without previous performance while Panel
B covers estimates with previous performance. Columns 1 to 3 and
columns 4 to 6 are for linear and nonlinear models respectively in
both panels.

Note on Panel C and D:

Implied sensitivity analyses in panel C and D refer to the change in
NDE scaled by change in BSO/S.

TABLE 9
{FORWARD LOOKING DESIGN}
{SUMYEAR + 1 + 2}

ESTIMATION OF PAYOFFS USING BLACK-SCHOLES VALUES OF BSO GRANTS
{N= 6,666; F = 1,476}

Panel A: {Regression Coefficients without Previous Performance}

                              1              2           3

Variable {Dependent:     Coefficients   t-statistic   p-value
OPINC1/S}

TA/S                        0.016          1.32        .187
BSO/S                       0.045          4.00        .000
[(BSO/S).sup.2]
RD/S                        0.347          26.42       .000
TCC/S                       -0.084         -7.32       .000
Adj. [R.sup.2] without      0.175
  dummies
Adj. [R.sup.2] overall      0.380

                              4              5

Variable {Dependent:     Coefficients   t-statistic
OPINC1/S}

TA/S                        0.013          1.12
BSO/S                       0.210          9.51
[(BSO/S).sup.2]             -0.174         -8.67
RD/S                        0.339          25.86
TCC/S                       -0.104         -8.91
Adj. [R.sup.2] without      0.187
  dummies
Adj. [R.sup.2] overall      0.386

Panel B: {with previous performance}

                              1              2           3

Variable {Dependent:     Coefficients   t-statistic   p-value
OPINC1/S}

TA/S                        -0.193        -17.06       .000
BSO/S                       0.049          4.97        .000
[(BSO/S).sup.2]
RD/S                        0.204          17.18       .000
TCC/S                       -0.067         -6.72       .000
(OPINC)t-1/S                0.502          45.48       .000
Adj. [R.sup.2] without      0.427
  dummies
Adj. [R.sup.2] overall      0.528

                              4              5

Variable {Dependent:     Coefficients   t-statistic
OPINC1/S}

TA/S                        -0.193        -17.17
BSO/S                       0.180          9.32
[(BSO/S).sup.2]             -0.138         -7.88
RD/S                        0.199          16.76
TCC/S                       -0.083         -8.17
(OPINC)t-1/S                0.498          45.29
Adj. [R.sup.2] without      0.434
  dummies
Adj. [R.sup.2] overall      0.532

Panel C: Economic effects sensitivity of various BSO
distribution {without previous performance}

                         LINEAR

Distribution   BSO/S    Effect on     Implied
Cutoff                  OPINC1/S    Sensitivity

FIRST          0.0002    0.0000        0.05
MEDIAN         0.0016    0.0000        0.05
THIRD          0.0015    0.0001

                        NONLINEAR

Distribution   BSO/S    Effect on     Implied
Cutoff                  OPINC1/S    Sensitivity

FIRST          0.0002    0.0000        0.21
MEDIAN         0.0016    0.0001        0.21
THIRD          0.0015    0.0003

Panel D: Economic effects sensitivity of various BSO
distribution {with previous performance}

                         LINEAR

Distribution   BSO/S    Effect on     Implied
Cutoff                  OPINC1/S    Sensitivity

FIRST          0.0002    0.0000        0.05
MEDIAN         0.0016    0.0000        0.05
THIRD          0.0015    0.0001

                        NONLINEAR

Distribution   BSO/S    Effect on     Implied
Cutoff                  OPINC1/S    Sensitivity

FIRST          0.0002    0.0000        0.18
MEDIAN         0.0016    0.0001        0.18
THIRD          0.0015    0.0003

Notes on Panels A & B:

The 'forward-looking' design model {SumYear + 1 + 2} is
estimated using 6,666 firm-year observations for a total
of 1,476 firms with no missing data. Firm years span
through 1992 to 2001. OPINC1 is sum of operating income
for two years following the grant year {the dependent
measure}; OPINC is annual operating income, Sales is annual
sales, BSO is Black-Scholes value of options grants to top
5 corporate executives as per Execucomp, ASSETS is year-end
balance sheet value of total assets (TA), TCC is cash
compensation for top 5 corporate executives as per Execucomp
and R&D is research and development expenditure. Missing
values of R&D are set to zero. All variables are scaled by
sales. Years are indexed by t and firms by i, time and
industry dummies are suppressed for expositional convenience.
Panel A is with respect to estimates without previous
performance while Panel B covers estimates with previous
performance. Columns 1 to 3 and columns 4 to 6 are for linear
and nonlinear models respectively in both panels.

Note on Panel C and D:

Implied sensitivity analyses in panel C and D refer to the
change in OPINC1/S scaled by change in BSO/S.

TABLE 10: {FORWARD LOOKING DESIGN}
{SUMYEAR + 1 + 2}
ESTIMATION OF PAYOFFS USING BLACK-SCHOLES VALUES OF BSO GRANTS
{N= 6,666; F = 1,476}

Panel A: {Regression Coefficients without Previous Performance}

                               1              2           3

Variable                  Coefficients   t-statistic   p-value
{Dependent: NDE1/S}

TA/S                         -0.065         -5.26        .000
BSO/S                        0.039          3.32         .001
[(BSO/S).sup.2]
RD/S                         0.400          29.29        .000
TCC/S                        -0.475        -39.93        .000
Adj. [R.sup.2] without       0.270
  dummies
Adj. [R.sup.2] overall       0.330

                               4              5           6

Variable                  Coefficients   t-statistic   p-value
{Dependent: NDE1/S}

TA/S                         -0.067         -5.43        .000
BSO/S                        0.167          7.26         .000
[(BSO/S).sup.2]              -0.135         -6.46        .000
RD/S                         0.394          28.82        .000
TCC/S                        -0.491        -40.55        .000
Adj. [R.sup.2] without       0.277
  dummies
Adj. [R.sup.2] overall       0.334

Panel B: {with previous performance} TA/S

                               1              2           3

Variable                  Coefficients   t-statistic   p-value
{Dependent: NDE1/S}

TA/S                         -0.076         -7.38        .000
BSO/S                        0.042          4.30         .000
[(BSO/S).sup.2]
RD/S                         0.187          15.37        .000
TCC/S                        -0.307        -29.21        .000
(NDE)t-1/S                   0.513          52.51        .000
Adj. [R.sup.2] without       0.512
  dummies
Adj. [R.sup.2] overall       0.528

                               4              5           6

Variable                  Coefficients   t-statistic   p-value
{Dependent: NDE1/S}

TA/S                         -0.078         -7.57        .000
BSO/S                        0.158          8.17         .000
[(BSO/S).sup.2]              -0.122         -6.94        .000
RD/S                         0.182          14.94        .000
TCC/S                        -0.321        -30.10        .000
(NDE)t-1/S                   0.512          52.59        .000
Adj. [R.sup.2] without       0.516
  dummies
Adj. [R.sup.2] overall       0.531

Panel C: Economic effects sensitivity of various BSO distribution
{without previous performance}

                         LINEAR

Distribution   BSO/S    Effect on     Implied
Cutoff                   NDE1/S     Sensitivity

FIRST          0.0002    0.0000        0.04
MEDIAN         0.0016    0.0000        0.04
THIRD          0.0015    0.0001

                        NONLINEAR

Distribution   BSO/S    Effect on     Implied
Cutoff                   NDE1/S     Sensitivity

FIRST          0.0002    0.0000        0.17
MEDIAN         0.0016    0.0001        0.17
THIRD          0.0015    0.0003

Panel D: Economic effects sensitivity of various BSO distribution
{with previous performance}

                         LINEAR

Distribution   BSO/S    Effect on     Implied
Cutoff                   NDE1/S     Sensitivity

FIRST          0.0002    0.0000        0.04
MEDIAN         0.0016    0.0000        0.04
THIRD          0.0015    0.0001

                        NONLINEAR

Distribution   BSO/S    Effect on     Implied
Cutoff                   NDE1/S     Sensitivity

FIRST          0.0002    0.0000        0.16
MEDIAN         0.0016    0.0001        0.16
THIRD          0.0015    0.0002

Notes on Panels A & B:

The 'forward-looking' design model {SumYear + 1 + 2} is
estimated using 6,666 firm-year observations for a total
of 1,476 firms with no missing data. Firm years span
through 1992 to 2001. NDE1 is sum of nondiscretionary
earnings for two years following the grant year {the
dependent measure}; NDE is nondiscretionary earnings,
Sales is annual sales, BSO is Black-Scholes value of
options grants to top 5 corporate executives as per
Execucomp, ASSETS is year-end balance sheet value of
total assets (TA) and R&D is research and development
expenditure. Missing values of R&D are set to zero. All
variables are scaled by sales. Years are indexed by t and
firms by i, time and industry dummies are suppressed for
expositional convenience. Panel A is with respect to
estimates without previous performance while Panel B
covers estimates with previous performance. Columns 1 to
3 and columns 4 to 6 are for linear and nonlinear models
respectively in both panels.

Note on Panel C and D:

Implied sensitivity analyses in panel C and D refer to the
change in NDE1/S scaled by change in BSO/S.

TABLE 11
{FORWARD LOOKING DESIGN}
{SUMYEAR + 1 + 2 + 3}
ESTIMATION OF PAYOFFS USING BLACK-SCHOLES VALUES OF BSO GRANTS
{N= 5,357; F = 1,283}

Panel A: {Regression Coefficients without Previous Performance}

                               1              2           3

Variable                  Coefficients   t-statistic   p-value
{Dependent: OPINC2/S}

TA/S                         0.055          4.33        .000
BSO/S                        0.055          4.68        .000
[(BSO/S).sup.2]
RD/S                         0.405          28.15       .000
TCC/S                        -0.096         -7.93       .000
Adj. [R.sup.2] without       0.264
  dummies
Adj. [R.sup.2] overall       0.395

                               4              5

Variable                  Coefficients   t-statistic
{Dependent: OPINC2/S}

TA/S                         0.055          4.33
BSO/S                        0.148          7.35
[(BSO/S).sup.2]              -0.105         -5.68
RD/S                         0.395          27.28
TCC/S                        -0.109         -8.90
Adj. [R.sup.2] without       0.267
  dummies
Adj. [R.sup.2] overall       0.398

Panel B: {with previous performance}

                               1              2           3

Variable                  Coefficients   t-statistic   p-value
{Dependent: OPINC2/S}

TA/S                         -0.118        -10.41       .000
BSO/S                        0.073          7.32        .000
[(BSO/S).sup.2]
RD/S                         0.193          14.77       .000
TCC/S                        -0.050         -4.87       .000
(OPINC)t-1/S                 0.548          45.76       .000
Adj. [R.sup.2] without       0.502
  dummies
Adj. [R.sup.2] overall       0.567

                               4              5

Variable                  Coefficients   t-statistic
{Dependent: OPINC2/S}

TA/S                         -0.118        -10.36
BSO/S                        0.130          7.61
[(BSO/S).sup.2]              -0.064         -4.10
RD/S                         0.187          14.31
TCC/S                        -0.059         -5.59
(OPINC)t-1/S                 0.546          45.53
Adj. [R.sup.2] without       0.503
  dummies
Adj. [R.sup.2] overall       0.568

Panel C: Economic effects sensitivity of various BSO distribution
{without previous performance}

Distribution               LINEAR
Cutoff

                BSO/S    Effect on     Implied
                         OPINC2/S    Sensitivity

FIRST           0.0002    0.0000        0.06
MEDIAN          0.0004    0.0000        0.06
THIRD           0.0011    0.0001

Distribution    NONLINEAR
Cutoff

                         Effect on     Implied
                BSO/S    OPINC2/S    Sensitivity

FIRST           0.0002    0.0000        0.15
MEDIAN          0.0004    0.0001        0.15
THIRD           0.0011    0.0002

Panel D: Economic effects sensitivity of various BSO distribution
{with previous performance}

Distribution              LINEAR
Cutoff

                BSO/S    Effect on     Implied
                         OPINC2/S    Sensitivity

FIRST           0.0002    0.0000        0.07
MEDIAN          0.0004    0.0000        0.07
THIRD           0.0011    0.0001

Distribution    NONLINEAR
Cutoff

                         Effect on     Implied
                BSO/S    OPINC2/S    Sensitivity

FIRST           0.0002    0.0000        0.13
MEDIAN          0.0004    0.0001        0.13
THIRD           0.0011    0.0001

Notes on Panels A & B:

The 'forward-looking' design model {SumYear + 1 + 2 + 3} is estimated
using 5,357 firm-year observations for a total of 1,283 firms with no
missing data. Firm years span through 1992 to 2001. OPINC2 is sum of
operating income for three years following the grant year {the
dependent measure}; OPINC is annual operating income, Sales is annual
sales, BSO is Black-Scholes value of options grants to top 5 corporate
executives as per Execucomp, ASSETS is year-end balance sheet value of
total assets (TA), TCC is cash compensation for top 5 corporate
executives as per Execucomp and R&D is research and development
expenditure. Missing values of R&D are set to zero. All variables are
scaled by sales. Years are indexed by t and firms by i, time and
industry dummies are suppressed for expositional convenience. Panel
A is with respect to estimates without previous performance while
Panel B covers estimates with previous performance. Columns 1 to 3
and columns 4 to 6 are for linear and nonlinear models respectively
in both panels.

Note on Panel C and D:

Implied sensitivity analyses in panel C and D refer to the change in
OPINC2/S scaled by change in BSO/S.

TABLE 12
{FORWARD LOOKING DESIGN}
{SUMYEAR + 1 + 2 + 3}
ESTIMATION OF PAYOFFS USING BLACK-SCHOLES VALUES OF BSO GRANTS
{N= 5,357; F = 1,283}

Panel A: {Regression Coefficients without Previous Performance}

Variable                      1              2           3
{Dependent: NDE2/S}

                         Coefficients   t-statistic   p-value

TA/S                        -0.035         -2.93       .003
BSO/S                       0.068          6.08        .000
[(BSO/S).sup.2]
RD/S                        0.450          33.15       .000
TCC/S                       -0.589        -51.74       .000
Adj. [R.sup.2] without      0.411
  dummies
Adj. [R.sup.2] overall      0.462

Variable                      4              5
{Dependent: NDE2/S}

                         Coefficients   t-statistic

TA/S                        -0.035         -2.96
BSO/S                       0.167          8.81
[(BSO/S).sup.2]             -0.112         -6.46
RD/S                        0.438          32.18
TCC/S                       -0.603        -52.21
Adj. [R.sup.2] without      0.417
  dummies
Adj. [R.sup.2] overall      0.466

Panel B: {with previous performance} TA/S

Variable                      1              2           3
{Dependent: NDE2/S}

                         Coefficients   t-statistic   p-value

TA/S                        -0.066         -6.82       .000
BSO/S                       0.083          9.13        .000
[(BSO/S).sup.2]
RD/S                        0.166          13.54       .000
TCC/S                       -0.373        -36.98       .000
(NDE)t-1/S                  0.547          52.52       .000
Adj. [R.sup.2] without       0.63
  dummies
Adj. [R.sup.2] overall      0.647

Variable                      4              5
{Dependent: NDE2/S}

                         Coefficients   t-statistic

TA/S                        -0.066         -6.84
BSO/S                       0.152          9.87
[(BSO/S).sup.2]             -0.078         -5.56
RD/S                        0.160          12.99
TCC/S                       -0.384        -37.45
(NDE)t-1/S                  0.544          52.36
Adj. [R.sup.2] without      0.633
  dummies
Adj. [R.sup.2] overall      0.649

Panel C: Economic effects sensitivity of various BSO distribution
{without previous performance}

Distribution                LINEAR
Cutoff
                           Effect on     Implied
                 BSO/S      NDE2/S     Sensitivity

FIRST           0.0002      0.0000        0.07
MEDIAN          0.0004      0.0000        0.07
THIRD           0.0011      0.0001

Distribution               NONLINEAR
Cutoff

                 BSO/S     Effect on     Implied
                            NDE2/S     Sensitivity

                0.0002      0.0000        0.17
                0.0004      0.0001        0.17
FIRST           0.0011      0.0002
MEDIAN
THIRD

Panel D: Economic effects sensitivity of various BSO distribution
{with previous performance}

Distribution                LINEAR
Cutoff
                           Effect on     Implied
                 BSO/S      NDE2/S     Sensitivity

FIRST           0.0002      0.0000        0.08
MEDIAN          0.0004      0.0000        0.08
THIRD           0.0011      0.0001

Distribution               NONLINEAR
Cutoff

                 BSO/S     Effect on     Implied
                            NDE2/S     Sensitivity

                0.0002      0.0000        0.15
                0.0004      0.0001        0.15
FIRST           0.0011      0.0002
MEDIAN
THIRD

Notes on Panels A & B:

The 'forward-looking' design model {SumYear + 1 + 2 + 3} is estimated
using 5,357 firm-year observations for a total of 1,283 firms with
no missing data. Firm years span through 1992 to 2001. NDE2 is sum of
nondiscretionary earnings for three years following the grant year {the
dependent measure}; NDE is annual operating income, Sales is annual
sales, BSO is Black-Scholes value of options grants to top 5 corporate
executives as per Execucomp, ASSETS is year-end balance sheet value of
total assets (TA), TCC is cash compensation for top 5 corporate
executives as per Execucomp and R&D is research and development
expenditure. Missing values of R&D are set to zero. All variables are
scaled by sales. Years are indexed by t and firms by i, time and
industry dummies are suppressed for expositional convenience. Panel
A is with respect to estimates without previous performance while
Panel B covers estimates with previous performance. Columns 1 to 3
and columns 4 to 6 are for linear and nonlinear models respectively
in both panels.

Note on Panel C and D:

Implied sensitivity analyses in panel C and D refer to the change in
NDE2/S scaled by change in BSO/S.

TABLE 13
{PROBABILITY OF BANKRUPTCY DESIGN}
DESCRIPTIVE STATISTICS AND CORRELATION MATRIX
{N= 8,217; F= 1,507}

Panel A: Descriptive Statistics

Variables            Mean      Std.      Median     Q1       Q3
                             deviation

SALES ($billion)    4.052      9.888     1.234    0.505    3.515
BSO grants          4.333     10.707     1.670    0.646    4.230
  ($million)
ASSETS ($billion)   3.668      9.151     1.001    0.393    2.960
PROBNKP             4.790      6.356     3.470    2.310    5.340
EPS (ERNVOL)        0.640      5.976     0.870    0.290    1.550
LEV                 30.670    94.262     29.140   9.770    44.580
GROWTH              4.440     11.577     2.760    1.850    4.460
SIZE /S             1.010      0.912     0.820    0.590    1.117
BSO/S               0.003      0.004     0.001    0.0004   0.003

Panel B: Correlation Matrix

Variables     ZSCORE/S     TA/S      BSO/S         TCC/S      EPS/S

PROBNKP/S        1
SIZE/S       0.002 (NS)     1
BSO/S          0.204      0.158        1
TCC/S          0.338      0.271      0.439           1
EPS/S          0.036      -0.048   0.014 (NS)   -0.002 (NS)     1
GROWTH/S       0.305      0.066      0.173         0.363      -0.005
LEV/S          -0.096     0.130      0.108         0.332      0.001

Variables    MV/S    DTC/S

PROBNKP/S
SIZE/S
BSO/S
TCC/S
EPS/S
GROWTH/S       1
LEV/S        0.070     1

Note on Panel A:

The probability of bankruptcy design is estimated using 8,217 firm-year
observations for a total of 1,507 firms with no missing data. Sales(S)
is annual sales, BSO is Black-Scholes value of options grants to top 5
corporate executives as per Execucomp, ASSETS (a measure of SIZE) is
year-end balance sheet value of total assets (TA), PROBNKP is the
Altman Z-score, EPS is earnings per share before extraordinary items
and discontinued operations, the standard deviation of which is used to
measure firm's volatility (ERNVOL), TCC is cash compensation for top 5
corporate executives as per Execucomp, LEV is long term debt to total
capital and GROWTH is Market to Book value ratio.

Note on Panel B:

Variables are as described above scaled by sales. All correlations are
significant at conventional thresholds except otherwise indicated as a
superscript NS.

TABLE 14
{PROBABILITY OF BANKRUPTCY DESIGN}
REGRESSION COEFFICIENTS ESTIMATES
{N= 8,217; F= 1,507}

Panel A: Prior 5 Year Growth Status

Variable                 Coefficients   t-statistic   p-value
{Dependent: PROBNKP}

SIZE/S                      -0.082         -7.02       .000
BSO/S                       0.046          4.00        .000
TCC/S                       0.327          25.55       .000
ERNVOL/S                    0.032          3.04        .002
GROWTH/S                    0.196          18.08       .000
LEV/S                       -0.216        -20.53       .000
Adj. [R.sup.2] without      0.206
  dummies
Adj. [R.sup.2] overall      0.213

Panel B: Current Year Growth Status SIZE/S

SIZE/S                      -0.081         -6.92       .000
BSO/S                       0.041          3.60        .000
TCC/S                       0.317          24.91       .000
ERNVOL/S                    0.031          3.02        .003
GROWTH/S                    0.225          20.81       .000
LEV/S                       -0.211        -20.19       .000
Adj. [R.sup.2] without      0.215
  dummies
Adj. [R.sup.2] overall      0.233

The probability of bankruptcy design is estimated using 8,217 firm-year
observations for a total of 1,507 firms with no missing data. Firm
years span through 1992 to 2001. Sales is annual sales, BSO is
Black-Scholes value of options grants to top 5 corporate executives as
per Execucomp, ASSETS (a measure of SIZE) is year-end balance sheet
value of total assets (TA), TCC is cash compensation for top 5
corporate executives as per Execucomp, PROBNKP is the Altman Z-score,
ERNVOL/S, measuring volatility is the standard deviation of earnings
per share before extraordinary items and discontinued operations,
LEV/S) is long term debt to total capital and GROWTH is Market to Book
value ratio. While the growth measure in Panel A is the average prior
5 year period, the corresponding measure in Panel B is the year t
measure. All variables are scaled by sales. Years are indexed by t
and firms by i, time and industry dummies are suppressed for
expositional convenience.
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Author:Akindayomi, Akinloye; Warsame, Hussein A.
Publication:Academy of Accounting and Financial Studies Journal
Article Type:Report
Geographic Code:1USA
Date:Jan 1, 2012
Words:19223
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