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Stock options rules in Malaysia and Japan: a comparative analysis.

INTRODUCTION

In the USA, Baker (1940) analyzed the stock options used as a form of executive compensation in late 1920s to 1930s. As for accounting treatment for employee stock options, Dillavou (1945) supported measuring and recognizing operating expense when the option was exercised. So the history of stock option plans in the USA will be nearly a century.

Compared with the length of the history of employee stock options in the USA, the history of them in Malaysia and in Japan are relatively short. The real history of stock options began in Malaysia from 1980s and that in Japan from late 1990s.

Malaysia is a country where variety co exists in harmony. As for the composition of the population of 27.17 million, Malays consists more than 50%, Chinese 25%, Indians 10 %, and Bumiputeras and other races make up the rest. Although Malay is the national language, English is widely spoken. Islam is the official religion, but other religions are widely practiced (Malaysia Tourism Promotion Board, 2009). As for economy, Malaysia is becoming financial center for Islamic banking in the Southeast Asia. As for Japan, Tokyo Stock Exchange is the second largest stock exchange in the world when measured by the size of domestic equity market capitalization, and the fourth largest when measured by the size of share trading value (WFE, 2009). In this paper, situations of the different kind of countries in Asia, Malaysia and Japan, are compared and analyzed.

As each country has its own social rules based on its own history and culture, introduction of new accounting standards will have different effect among countries. IFRS 2 (International Financial Reporting Standard 2 Share-based Payment) affected accounting standards in Malaysia and Japan. FRS 2 (Financial Reporting Standard 2 Share-based Payment) in Malaysia, and ASBJ Statement 8 (ASBJ Statement No.8 Accounting Standard for Share-based Payment) in Japan, both adopted modified grant date fair value accounting for stock options. But the situation of stock option plans, not only before, but also after the adoption of new accounting standards, are different between Malaysia and Japan. As for taxation, in Japan, preferential tax treatment is introduced for qualified stock option plans, but in Malaysia such treatment is not introduced. In Malaysia, stock options are used mainly as an additional executive compensation among listed companies but the amount is not so large. In Japan, beside the ordinary use of stock options, they are also used to substitute lump sum cash payment at the retirement of the officers.

In this paper, history of accounting, taxation, and law in Malaysia and Japan are explained and difference in stock option plans are analyzed to clarify that social rules in each nation affects the outcome of the application of new accounting standards.

HISTORY OF STOCK OPTIONS IN MALAYSIA

Overview of the history

Stock options also known as share options in Malaysia is a new phenomenon among corporate entities in Malaysia. Public listed companies on the Bursa Malaysia (formerly known as Kuala Lumpur Stock Exchange) began to issue stock options to its executives as a way of compensation in 1980s (Ariff, Mohamad, & Nassir, 1998). Although Malaysia gained independence in 1957, companies were small in size and were mostly involved in the mining and agriculture sectors. After independence, Malaysia relied heavily on the exports of raw materials and commodities such as rubber, tin and others. Malaysia, a middle-income and fast developing country transformed itself from 1971 through the late 1990s, from a producer of raw materials into an emerging multi-sector economy. Transformation of the Malaysian economy took place in the mid-1980s. In the mid-1980s, Malaysia experienced a sharp fall in the price of natural commodities leading to a recession. This was the first major economic crisis of its kind faced by Malaysia after independence. From 1971 to 1990 the economy grew at 6.7% and from 1991 to 2000 the economic growth was on an average of 7%. The economy contracted by 7.4% in 1998 following the financial crisis, but it recovered in 1999 and grew by 8.5% in 2000 (Bank Negara Malaysia, 2001).

After a restructuring process, the economy bounced back, but mainly due to foreign investment in the manufacturing sector. Exports no longer were in rubber and other commodities only, but more of manufactured goods and products. The economic growth of Malaysia now is almost exclusively driven by exports particularly of electronic equipments, petroleum and liquefied natural gas, chemicals, palm oil, wood and wood products, rubber and textiles and other manufactured goods. Malaysian companies compared to the Japanese are small in size and only began to be involved in manufacturing and other industries in 1990s. As such, all aspects of stock options and other forms of employee compensations are relatively new in Malaysia.

Stock options became popular as a means to compensate executives beginning mid-1980s when the companies made huge profits. This, however, was short-lived when Malaysia and other neighboring countries faced the Asian financial and economic crisis in 1997. The crisis did not allow for the development of the stock options in Malaysia as much as in Japan, U.S.A. or other developed countries in the world. Currently almost all the companies listed in the Bursa Malaysia have stock options for their executives and employees (Bursa Malaysia, http://www.bursamalaysia.com/). However, issues related to stock options in Malaysia are not that big as in Japan, because the amount is not large and material.

Accounting Standard for Employee Stock Options in Malaysia

In Malaysia, the Malaysian Accounting Standards Board (MASB) is responsible for the promulgation and implementation of the accounting standards. Beginning January 1st 2006, MASB has issued new standards known as the Financial Reporting Standards (FRS) that are almost identical to the International Financial Reporting Standards (IFRS) issued by the IASB. FRS 2 is concerned about stock options in Malaysia. The main features of FRS 2 are similar to IFRS 2 and they are listed below.

The FRS 2 sets out measurement principles and specific requirements for three types of share-based payment transactions:

For equity-settled share-based payment transactions, all entities are to measure the goods and services received, and the corresponding increase in equity, directly at the fair value of the goods and services received, unless that fair value cannot be estimated reliably. If the fair value cannot be estimated reliably then the entity must estimate indirectly, i.e., by reference to the fair value of the equity instruments granted. For employee stock options, the fair value of the instruments granted is measured at grant date (FRS 2 par. IN5, pars. 10-12).

The FRS requires the fair value of equity instruments granted to be based on market price. When market prices are not available, fair value is to be estimated using the arm's length transactions technique (FRS 2 par. IN5, pars. 16-17).

For stock options that are modified, re-priced, cancelled or repurchased the FRS requires the entity to recognize, as a minimum the services received measured at the grant date fair value of the equity instruments granted (FRS 2 par. IN5, pars. 26-27).

Only after 2006 there were concerns about FRS 2 and the way accounting for it should be done. FRS 2 and other standards issued by the MASB have been enforced beginning January 2006. Since the standard requires companies to recognize compensation expenses every half-yearly, this gives rise to financial impact on the companies and their financial performance is severely affected. This has been the case for a number of companies in Malaysia since last year. In November 2006, Freight Management Holdings Bhd proposed the termination of its employees' stock options because of the fear of its impact on the financial performance for 2006 (Securities Commission Malaysia, http://www.sc.com.my).

This has also been the case for Key West Global Telecommunications Bhd, whereby the company has recognized compensation expense of RM790,000 for the first two quarters, but for the same period the company reported a net loss of RM385,000 (Securities Commission Malaysia, http://www.sc.com.my). Most companies are more worried about the financial impact as a result of recognizing compensation expenses in their financial statements.

Taxation of Employee Stock Options in Malaysia

Changes to the taxation of stock options in Malaysia took effect from the year of assessment 2006. Before year of assessment 2006, benefits derived from stock options by employees were deemed gross income and also subject to income tax. But, for the purpose of income tax, the value of the income from each share was determined based on the difference between the market price of the share on the date of offer and the discounted price for each share. It did not take into consideration the market value of the stock on the date when the stock option was exercised. The disposal value was not taken into consideration for tax purposes. So there was no tax imposed if the exercise price of the stock option was set at the market price on the grant date.

However, beginning YA 2006 this ruling has changed. The value of the benefit for each stock option is now determined based on the difference between the market price on the date the stock option is exercised or exercisable, whichever is lower, and the discounted price offered by the employer. Exercisable date means the date when the right shall be exercised, assigned, released or acquired if the right is exercisable on a specified date or otherwise. Furthermore, the benefit is liable to tax in the year the option is exercised. This will have an impact on the employees as to when they want to exercise their options. The employees must now decide as to when they would prefer to exercise their options. The timing to do that is also important.

HISTORY OF EMPLOYEE STOCK OPTIONS IN JAPAN

Overview of the history

Although, in Japan, there were research papers or monographs published in 1960s, such as Ikoma (1967), stock options were not widely used until late 1990s. Although in 1980s there were U.S. companies granted stock options directly to the officers of the subsidiary in Japan, the term "stock options" was not so popular until mid 1990s, when SOFTBANK and SONY introduced so called "quasi-stock options" in their compensation program. The trends of the number of the articles in the NIKKEI Newspaper are presented in Figure 1.

[FIGURE 1 OMITTED]

On October 4th in 1994, NIKKEI Newspaper reported that SOFTBANK was planning to introduce new compensation program using the shares of the principal stockholder. The principal stockholder sold his shares at low price (one third of the market price) to directors and key employees based on the contract between the principal stockholder and directors and key employees (Chuo Coopers & Lybrand Advisors, 1999, 255-256). As that compensation program had similar effect as introducing stock option plan, it was called "quasi-stock options" in Japan (Chuo Coopers & Lybrand Advisors, 1999, 231). According to the interim report of SOFTBANK, the principal stockholder effectively (directly and indirectly) held 70% of the outstanding shares on July 22nd in 1994, that made him possible to introduce such kind of compensation program. As the compensation program was introduced by the principal stockholder personally, no formal procedure was required for SOFTBANK except for the procedure to report the change in the number of shares that the principal stockholder holds (Chuo Coopers & Lybrand Advisors, 1999, 258-259).

Another kind of "quasi-stock options" was introduced by SONY in 1995, by utilizing bonds issued with detachable stock purchase warrants (NIKKEI Newspaper August 11, 1995; Chuo Coopers & Lybrand Advisors, 1999, 232-247; The Economist August 3, 1996, 56). Because Japanese Commercial Code at that time prevented Japanese corporations from granting stock options, stock purchase warrants were used to grant call options to the directors. At first, a bond with detachable stock purchase warrants was issued. Next, all of the stock purchase warrants were purchased. Finally, stock purchase warrants were made non-transferable by the contract, and granted to the directors. What the directors received as compensation were nothing but stock options in substance, but their legal form - reissued stock purchase warrants - made them legal. Accounting treatment for this type of stock options was quite unique, because it required recognition of compensation cost as an expense (or distribution of earnings), based on the fair value of stock purchase warrants on the grant date.

In October 1995, New Business Promotion Act was amended, and 27 designated small high tech firms were allowed to include stock option plans in their compensation program (Keieizaimu, November 20, 1995, 2-4). As the Commercial Code Article 280-2 at that time limited the effective period of special resolution of the shareholders' meeting to six month, New Business Promotion Act Article 8 extended that period to ten years. By that amendment, it became possible to introduce stock option plan by the approval of the shareholders' meeting to issue shares at the price significantly lower than the market price at the exercise date. Special Taxation Measures Law Article 29-2 was amended and preferential tax treatment for stock options for designated high tech firms were introduced in 1996.

By the amendment of the Commercial Code in 1997, two types of stock option plans, treasury stock type and stock purchase right type, were introduced.

Before the amendment in 2001, Commercial Code did not permit corporations to acquire their own shares other than in exceptional cases, which were specified in the Code. Before the amendment in 1994, the Commercial Code allowed corporations to acquire treasury stocks only for the following four reasons: (a) to cancel, (b) as a result of merger or bulk acquisition of other corporations, (c) for execution or payment, (d) for appraisal right of shareholders (Nakamura, 1996, 46). By the amendment in 1994, the following three reasons were added: (a) to sell shares to employees within six month, (b) to cancel shares based on the resolution at shareholders' meeting, (c) for appraisal right of shareholders of close corporations (Nakamura, 1996, 47).

By the amendment in 1997, the Commercial Code allowed corporations to acquire their own shares for stock option purpose (Article 210-2). As the reduction of capital stock was not allowed without following the due process strictly required by the Commercial Code, treasury stocks were treated as asset. Although treasury stocks were presented as deduction from the total capital in consolidated balance sheet, their realized gain or loss when they were sold, affected the consolidated surplus (retained earnings). Moreover, they were presented as assets on the balance sheet of the parent corporation.

For the preferential treatment under the Japanese Income Tax Law, it was necessary to set the exercise price at least equal to the price of the treasury stock at the grant date. Therefore, compensation cost was not recognized when granting this type of stock options. However, because treasury stocks were treated as assets, when they were reissued, any difference between the book value and the reissue price was reported as a gain or loss in the income statement. Although, treasury stocks were presented as a deduction from capital instead of an asset, the gain or loss recognized by the transaction of treasury stocks affected the consolidated surplus (retained earnings). That means they were treated as assets in measuring profit or loss, in spite of their presentation in the consolidated balance sheet.

By the amendment of the Commercial Code in May 1997, as from October of that year, Japanese corporation were allowed to grant stock options by granting stock purchase rights to their directors and employees (Article 280-19). However, a resolution at the shareholders' meeting must be approved by two-third majority. Because the Commercial Code did not allow contribution by service for shares, compensation cost for stock options was not recognized as an expense. No entry was made on the grant date, and the entry was made when they were exercised. As in the case of treasury stock type, the compensation cost for stock options was not reported in the income statement for this type of stock options. In the case of taxation, the same preferential treatment was applied. But, the approval by two-third majority was required; this type of stock option plan was not as popular as treasury stock type.

Before the amendment of the Commercial Code in 2001, it was not allowed to issue call options except for specific purposes allowed in the Code. Stock options based on the Commercial Code Article 280-19, convertible debt and debt issued with stock purchase warrants were those exceptions (Takei & Shimizu, 2002, 199). Because the stock options allowed in the Commercial Code amended in 1997 limited the grantee to directors and employees of the company, in order to grant stock options to the officers or employees of the subsidiaries or affiliated companies, it was still necessary to use quasi-stock options.

The amendment of the Commercial Code in 2001 allowed grant call options to anybody, and for any purpose if approved by the special resolution (two-third majority) of the shareholders' meeting. Grantees of the stock options were no longer limited to directors or employees of the corporation, and call options were no longer required to be packaged with debt (Egashira, 2009, 713). The reason for allowing corporations to issue call options in general was that it became possible to measure the fair value of call options when they are issued. It was argued that shareholders could compare the value of call options issued and the value of consideration for those call options (Takei & Shimizu, 2002, 200).

As a result of the amendment, as for the legal procedure, stock options, convertible debt, debt issued with stock purchase warrants were regulated under the same articles which rules about subscription rights to shares. As for accounting, it followed the legal form of the transaction. When stock options were granted as issuing subscription rights to shares without consideration, then there was no entry for recognizing compensation cost.

Accounting Standard for stock options in Japan

The Accounting Standards Board of Japan (ASBJ), Japanese private sector accounting standards setting body, began its deliberation on accounting for stock options in 2002. Stock Option Technical Committee was established in May, and Summary Issues Paper Accounting for Stock Option was published in December.

In December 2004, ASBJ published the Exposure Draft Accounting Standard for Stock Options. In the Exposure Draft, it was proposed to require an entity to reflect in its profit or loss and financial position the effects of stock options. It was proposed to require a fair value method of accounting for stock options. The fair value of stock options is estimated at the grant date, and the total amount of compensation cost recognized will be based on the number of stock options eventually vest. Those proposals are in accordance with the requirements of the IFRS 2 issued in February 2004. It was also proposed that the credit account for the recognized compensation cost should be presented as an item between liability and equity (the mezzanine section of the balance sheet). When the vested options expire without exercised, the balance of subscription rights to shares account would be recognized as gain and reported on the income statement. Non public companies were allowed to use intrinsic value at the grant date without reflecting subsequent change in intrinsic value. Those proposals were departure from the requirements of the IFRS 2.

In August 2005, ASBJ issued Exposure Draft Accounting Standard for Presentation of Net Assets in the Balance Sheet and Exposure Draft Guidance on Accounting Standard for Presentation of Net Assets in the Balance Sheet. Subscription Rights to Shares was presented among current liabilities on the balance sheet, but ASBJ proposed to change that the balance sheet classification of Subscription Rights to Shares, because it does not meet the definition of liability, and required that item to be presented among Net Assets, but in the independent section separated from Shareholders' Capital.

In October 2005, ASBJ published the revised version of the Exposure Draft Accounting Standard for Share-based Payment and the Exposure Draft Guidance on Accounting Standard for Share-based Payment. Reflecting the new balance sheet classification proposed by the Exposure Draft Accounting Standard for Presentation of Net Assets in the Balance Sheet, It was proposed that the credit account for the recognized compensation cost should be presented in the independent item within the Net Assets section separated from the subsection Shareholders' Capital.

On December 9th 2005, ASBJ issued ASBJ Statement No. 5 Accounting Standard for Presentation of Net Assets in the Balance Sheet and ASBJ Guidance No. 8 Guidance on Accounting Standard for Presentation of Net Assets in the Balance Sheet to change the balance sheet classification of Subscription Rights to Shares, and on 27th, Statement No. 8 Accounting Standard for Share-based Payment and ASBJ Guidance No. 11 Guidance on Accounting Standard for Share-based Payment. Most of the accounting treatments required by ASBJ Statement 8 are in accordance with the IFRS 2. But there are following two material differences; (a) Forfeiture of vested stock options results in recognizing gain and (b) Intrinsic value at the grant date allowed for non public companies.

Subscription Rights to Shares is presented in the Net Assets section on the balance sheet until exercised or expired, but as the independent item separated from Shareholders' Capital (ASBJ Statement 5, par.7). If the rights are exercised, the amount presented as Subscription Rights to Shares becomes paid-in capital, but if not, it does not become paid-in capital but a gain. Although such kind of suspense accounts used to be presented among liabilities, as Subscription Rights to Shares do not meet the definition of liabilities, it is presented in the Net Assets section (par.22).

ASBJ Statements follow the narrow definition of paid-in capital. Paid-in capital is the amount invested by the shareholders. As the holders of subscription rights to shares are not shareholders yet, the consideration for subscription rights do not constitute Shareholders' Capital. This narrow definition is in accordance with the definition provided in The Series of Discussion Papers "Conceptual Framework of Financial Accounting" published in 2004 by the Working Group on Fundamental Concepts organized by the ASBJ. According to the Japanese Conceptual Framework, net assets consist of Shareholders' Capital, which is attributable to shareholders, and other components of net assets, which include portions attributable to parties other than shareholders and portions not attributable to any party. Minority Interests on the consolidated financial statements and the transactions with optionees who may become owners are included in net assets attributable to parties other than owners of the reporting entity (Discussion Paper "Elements of Financial Accounting" par.6, footnote4). When vested subscription rights to shares expire, the corresponding amount recorded in Subscription Rights to Shares account will be transferred to Shareholders' Capital (retained earnings) through profit (ASBJ Statement 8, par.9).

In IFRS 2, it is required that the entity shall make no adjustment to total equity after vesting date; the entity shall not subsequently reverse the amount recognized for services received from an employee if the options are not exercised. And it is also stated that requirement does not preclude the entity from recognizing a transfer within equity, ie a transfer from one component of equity to another (par.23). ASBJ Statement 8 does not require reversing the amount recognised for service received and it does not change the total equity. However, when option expires, the corresponding amount will be transferred to an account such as "Gain from Expired Subscription Rights to Shares" and reported in the income statement as a component of net income (par.47). Increasing net income when option expires is a departure from IFRS 2. Option holders are not considered as owners of the entity within the Japanese Conceptual Framework.

ASBJ Statement 8 allows non public companies to use the intrinsic value instead of fair value at the grant date, for measuring the amount to

be recognized as an expense for share options (par.13). If company selects to use intrinsic value, total intrinsic value of share options at the end of each period and total intrinsic value of the exercised options at the exercise date are required to disclose in notes (par.16). As for non public companies in Japan, they can grant share options without recognizing compensation expense in the income statement. When the entity was unable to estimate the fair value at the measurement date, IFRS 2 requires measuring the intrinsic value and subsequently at each reporting period and at the date of final settlement, with any change in intrinsic value recognized in profit or loss (par.24). As Japanese accounting standard does not require recognizing change in intrinsic value, accounting for non public companies is different from IFRS 2.

Taxation for Employee Stock Options in Japan

The Japanese Corporation Tax Act was revised in March, 2006 in line with the new accounting standard for stock option expenses. Although both of qualified stock options and nonqualified stock options are able to recognized as compensation expenses in financial accounting after May 1st 2006, under this revision of taxation for stock options, only grantors of nonqualified stock options are able to include for stock option expense for taxation (Corporation Tax Act 54).

From the perspective of taxation there are three types of stock option plans in Japan: "qualified stock options," "non-transferable and non-qualified stock options" and "transferable and non-qualified stock options" (Ishii 2002, 50-55; Yamada 2003, 116-124).

For companies which granted stock options based on the plans according to the Commercial Code, it was not possible to deduct the compensation cost of stock option plans from the taxable income before the revision of Japanese Corporation Tax Act in 2006, although it was possible to deduct the compensation cost if the plan took the form of "quasi-stock options" using warrants issued with debt, instead of taking the form specified in the Commercial Code.

From May 1st, 2006, non-qualified stock options which are granted to the service providers were able to be treated as an expense for corporation tax purpose (Corporation Tax Act 54). The timing of inclusion in expense for company will be the day in which the service providers will be taxed for their income (Corporation Tax Act 54). That will be exercise date for non-transferable and non-qualified stock options and grant date for transferable and nonqualified stock options.

The deductible amount for stock options will be the same with the compensation expenses (Order for Enforcement of the Corporation Tax Act 111-2). Therefore, the valuation method in taxation for non-qualified stock options for the company will be the same with the method of accounting which could be based on grant-date fair value for public company and could be based on the fair value or the intrinsic value at the grant date for non public companies (ASBJ Statement 8, pars. 5, 6, 13). Although the deductible amount for stock options will be the same with the compensation expenses, there is a difference in the time of recognition between reporting purpose and tax purpose. And, as for qualified stock options, even if compensation expenses were recognized for the reporting purpose, those expenses will not be tax-deductible.

In regardless of "qualified" stock options or not, companies must adjust their taxable income both on the grant date and the exercise date for tax purpose. Additional burden will be imposed for companies by the difference between tax accounting and financial accounting.

As for income tax for employees, it is necessary to distinguish into three categories, qualified stock options, non-transferable non-qualified stock options, and transferable nonqualified stock options.

Qualified stock options provide tax advantages for the employee as grantee that a nonqualified stock option does not. Taxation for qualified stock options is deferred until the shares are sold by the grantee (Order for Enforcement of the Income Tax Act 84, Act on Special Measures Concerning Taxation 29-2). A 10% for capital gains tax rate will be applied on publicly listed stocks and a 20% for its rate will be applied on unlisted stocks (Order for Enforcement of the Act on Special Measures Concerning Taxation 19-3, Act on Special Measures Concerning Taxation 37-10). Although a 10% tax rate for publicly listed stocks will be hold until 2007, and from then will be 20% by the original schedule of regulations. There are numerous restrictions which have to be met in order to qualify as qualified stock options (Nakamura and Matsushita 2003, 84). This preferential tax treatment has been extended until 2011 (http://www.nta.go.jp/taxanswer/shotoku/1463.htm).

Stock options shall be issued without payment. Persons eligible for assignment are directors, executive officers, and employees of the company and its subsidiaries, apart from its major shareholders and special interest parties. The period for exercising stock options shall be not later than ten years and not less than two years after the date of the resolution. Maximum tax advantage per year shall be JPY 12,000,000, the sum of exercised amounts. The exercising price shall be higher than the market price at the grant date. Transferring stock options shall be prohibited (Order for Enforcement of the Act on Special Measures Concerning Taxation 19-3).

Non-transferable and non-qualified stock options are only made into profit by exercising the right of stock option. The employees as grantee taxed on the difference between the market price of shares and the strike price plus issuing price of stock options (Order for Enforcement of the Income Tax Act 84). As for corporation tax purpose, the companies are able to deduct compensation expense on the exercise date by the same amount recognized for financial reporting purpose. What that means is that the valuation of stock options is the fair value for public company and the intrinsic value for non public company at the grant date. So the amount that corporation can deduct for tax purpose and the amount of income that employees report might be different.

The type of income is decided by the purpose of the stock options and the nature of the relationship between grantee and grantor; consequently, it is defined as employment income, business income, or miscellaneous income under the Primary Regulation Notice of Income Tax Law 23~35. The tax rates for employment income are from 5% to 40% (10% to 37% until FY2006) plus 10 % local tax (5% to 13% until FY2006), for business income approximately 50% (including local tax), and for miscellaneous income 15% plus local tax 5%. When shares are sold, tax is imposed on the capital gain. That rate is 10% (Order for Enforcement of the Act on Special Measures Concerning Taxation 19-3 and Act on Special Measures Concerning Taxation 37-10).

Transferable and non-qualified stock options are taxed on the difference between the price of stock options and their fair value on the grant date (Income Tax Act 36 and Primary Notice on Income Tax Act 36-36). It is the same for non-transferable and non-qualified stock options on the case of issued stock options with fair value, the employees as grantee will be taxed for capital gain at the time of selling stocks.

Income tax is not imposed on the exercise date. When the shares are sold, tax will be imposed for the capital gains (Order for Enforcement of the Act on Special Measures Concerning Taxation 19-3 and Act on Special Measures Concerning Taxation 37-10). Capital gain is calculated by the difference between the strike price plus issuing price of stock option and the market price of shares (Primary Notice on Income Tax Act 48-6-2).

When it is based on the amended corporate tax law, companies are able to deduct compensation expense at the same time when the employees report their income for tax purpose (Corporation Tax Act 54). Companies will be able to deduct compensation expense for stock options at the grant date for tax purpose and reporting purpose in the same period.

EFFECT OF THE ADOPTION OF IFRS 2 AS FRS 2 IN MALAYSIA

Before the adoption of grant date fair value accounting for stock options in Malaysia, most of the listed companies used stock options as an additional form of executive compensation. As the adoption of grant date fair value accounting required companies to recognize expense for granting stock options, that discouraged companies from granting stock options to their employees, as some cases were mentioned previously in this paper. The reaction to the new standards observed in Malaysia was quite similar to that in the U.S. In the U.S., after the adoption of the grant date fair value accounting, decrease in stock options and increase in restricted stocks were observed (Henry, 2009, 68; Carter, Lynch, & Tuna, 2007, 354).

The structure of accounting standards in Malaysia reflects the co existence of dual system in harmony. Accounting standards in Malaysia consist of three categories. First category is FRS that corresponds to IFRS or IAS (FRS with a '100 prefix'). Second category is FRS with a '200' prefix that is locally developed standards with no equivalent IFRSs. Third category is Islamic Accounting Standards (FRS i-1 2004, TR TR i-2, TR i-3, SOP As conventional banking and Islamic banking, both exist in Malaysia, it is necessary to have IFRSs and Islamic Accounting Standards. Although stock option plans might be a typical western style compensation scheme, it fit in the conventional part of the Malaysian business. As a result, the similar reaction could be observed after the adoption of IFRS 2.

Another issue related to stock option was tax reform. Before 2006, there was no tax imposed on the income from stock option. But after 2006, income tax was imposed on the difference between the market price and the exercise price of the shares on the exercise date. There is no preferential tax treatment for stock option plans in Malaysia.

EFFECT OF THE CONVERGENCE OF ACCOUNTING STANDARD FOR STOCK OPTIONS IN JAPAN

By ASBJ Statement No.8, it became necessary to recognize compensation expense to grant stock options in regardless of their legal form of the plans In order to analyze the effect of that accounting standard, NIKKEI 225 companies were selected as samples. Securities reports and business reports of those companies were collected by using YUHO KAKUMEI web database service provided by Hitachi High-Technologies Corporation. Among those two hundred and twenty five companies, fifty one companies were found as companies approved stock option plan in 2006. One hundred and seventy four companies did not propose stock option plan in 2006. Among fifty one companies approved stock option plan in 2006, forty six companies adopted stock option plan in 2005, so those companies adopted stock option plan two years in a row. Among one hundred and seventy four companies that did not propose stock option plan in 2006, seventeen adopted stock option plan in 2005, and twenty three companies have adopted stock option plan before 2004.

Among those fifty one companies approved stock option plans in 2006, two different types of stock options could be found. One was stock option with exercise price set at the market price on grant date (ordinary type), and the other with only a nominal exercise price, one yen per share (restricted stock type). Twenty five companies adopted ordinary stock option plans, nineteen companies adopted restricted stock type stock option plans, and seven companies adopted both types.

Similar tendency could be observed in other surveys. According to the survey conducted by Towers Perrin and Nikko Cordial Securities (2009), among three hundred eighty one companies granted stock options within July 2008 and June 2009, one hundred and fifty companies granted restricted stock type stock options. Another survey conducted by the Price Waterhouse Coopers HRS (2009) in 2008 with small samples (sixty eight companies) revealed that thirty two percent had ordinary stock option plans and fifteen percent had restricted stock type stock option plans. In the Survey edition of Commercial Law Review (No.307), among one hundred and thirteen companies with one hundred and twenty samples of the resolutions of the shareholders meeting to approve stock option plans in June 2009, forty five were restricted stock type stock options and seventy five were other kinds of stock options.

It can be observed that restricted stock type stock option plans are increasing. The restricted stock type stock option plans can be divided into two groups. One is for ordinary compensation and the other is substitute of the lump sum payment at the retirement for executives.

In Japan, when the executives retire, the company used to pay additional compensation as distribution of retained earnings by the resolution approved at the shareholders' meeting. As the legal form of the procedure was distribution of retained earnings, the accounting treatment followed that legal form and treated as direct reduction of retained earnings instead of recognizing expense. In 2005, ASBJ Statement No. 4 Accounting Standard for Directors' Bonus was issued and the accounting treatment for directors' bonus has been changed. The Statement requires that the directors' bonus shall be accounted for as an expense instead of a deduction from the amount of surplus. When the two alternatives, lump sum payment on retirement and restricted stock type stock option plan, are compared, expense has to be recognized for both, but the latter can avoid cash out flow. This seems to be one of the reasons for companies began to use restricted stock type stock options to substitute retirement lump sum payment.

Other reasons for increase in restricted type stock options will be explained in the next section.

ANALYSIS OF THE BACKGROUND FOR RESTRICTED STOCK TYPE STOCK OPTION PLANS

According to the Securities and Exchange Act of Japan Article 166 (Prohibited Acts of Corporate Insider), corporate insider who has come to know any material fact relating to the business shall not make any sale or purchase of any specified security of the listed company. A material fact includes any fact relating to management, business, operations, or property of the listed company, which exerts a significant influence on investment judgment of investors. This restriction made it difficult for directors and audit officers to sell their shares of the company. Securities and Exchange Act has been amended in 2006 and now it is Financial Instruments and Exchange Act, but Article 166 (Prohibited Acts of Corporate Insider) remains same restriction as before.

According to Article 164 (Restriction of Undue Profit Made by Officer or Major Shareholder), for the purpose of preventing an officer or a major shareholder of a listed company from taking advantage of any confidential information which they have obtained by dint of his/her functions or position in the listed company, the listed company may demand the officer or major shareholder to surrender to the listed company, any profit which the officer or major shareholder has realized by making the sale within six months of the purchase of a specified security of the listed company. In substance, this article prohibits the directors and audit officers to sell shares within six month after the purchase of those shares. According to Shimazaki (2004), because the purpose of stock option plans cannot be attained, Nippon Keidanren (the Japan Business Federation) requested to exempt the profit made by the sales of the shares purchased by stock option plan when applying Article 164, but the same restriction remains in Financial Instruments and Exchange Act.

It was also required by the Securities and Exchange Act (Article 163), in case where an officer or a major shareholder has made the purchase or the sale of a specified security issue by the listed company, the officer or major shareholder shall file with Prime Minister a report on his/her sale or purchase, not later than the fifteenth day of the month following the month to which the day of the sale or purchase belongs. Same article is found in Financial Instruments and Exchange Act.

Above mentioned restrictions by the Securities and Exchange Law of Japan made it difficult for the directors and audit officers to sell their shares of the company. But that might not be the only reason why those officers do not sell their shares of the company. There might be a common thought among the officers of the company that they should not sell their shares of the company, even if it is allowed by the Law. They may think that sales of the corporation's stock by them will be viewed as disloyal. According to Herzel & Perlman (1978), an article written in late 1970s in the USA, there might be real or imagined informal pressure on optionees to retain the corporation's stock. The situation in the USA seems to be changed and now as for the shares obtain by the exercise of stock options are sold immediately. According to Ofek & Yarmeck (2000), when executives exercise options to acquire stock, nearly all of the shares are sold by the typical manager. Sautner & Weber (2009) also found that most option recipients sell the shares acquired on exercise in their data set from one of the largest German corporation. But in Japan, that is not the case.

In 2003, there were three corporations listed on the First Section of the Tokyo Stock Exchange, which applied for legal reorganization procedure. Number of shares held by each director or auditor of those companies was compared with that of the previous year. Those data was available in the securities reports filed at the Finance Services Agency. It is not possible to directly obtain the number of the share executives sold. Only the number of shares each director or auditor hold was the available data. There were ninety two directors and audit officers in those companies after the accounting period that ends on March 31st, 1997. There were four audit officers who did not hold shares of the company, and there were eighteen directors and audit officers who provided only one year data from 1997 to 2003, the behavior of seventy directors and audit officers constituted the samples. More than seventy five percent of the directors and audit officers increased the number of shares of the company compared with the previous year, and the rest did not change the number of their shares of the company. Only one director decreased the number of the shares of the company once. Although the financial condition of the company was in serious trouble, the directors and audit officers did not decrease the number of shares they hold with only one exception, at least for the periods mentioned above.

By the survey of seventy eight companies from NIKKEI 225, among one thousand nineteen directors and auditors, only four decreased the number of shares during 2008 reporting period. Seven hundred fifty one increased, and two hundred and sixty four did not change including one hundred thirty who did not hold shares at all.

Although above data does not directly prove that Japanese officers do not sell shares, because that data directly show the number of shares the directors or auditors sold are not available, it is possible to state that Japanese officers gradually increase the number of shares they hold.

One of the explanations of the result would be that the restriction by the Financial Instruments and Exchange Act (Securities and Exchange Act) prevented those directors and audit officers from selling their shares. Another explanation would be that those directors and audit officers simply missed the timing to sell the shares of the company. The other explanation would be loyalty; the directors and auditors do not sell their shares because they feel they should not sell the shares of the company, they feel they owe something to the company.

Those attitude of the officers of Japanese companies to hold shares of the company might be one of the reason to explain why ordinary stock options were not been used so widely as in the USA. If the officers just receive dividends after exercising the options, the cost recognized on the books of the company will be greater than the benefit gained by the officers from the stock options. It might not be so effective to use stock option as a form of compensation in Japan.

On the contrary, restricted stock type stock options fits well with those attitude of the officers. Although their substance is shares, they cannot be sold until retirement. But that restriction does not matter so much for Japanese officers, because even if they were allowed to sell those shares, they would not do so.

Taxation also played an important role in the choice of the form of the compensation plan. It is better to use stock option as a form of compensation plan than to grant restricted stock itself. When the restricted stock itself is granted, that date will be the time when income tax will be imposed. In case of restricted stock type stock option, even if it is not qualified stock option for preferential treatment for tax purpose, still tax will be imposed when the stock option is exercised, not at the grant date.

SUMMARY AND CONCLUSION

In Japan, by the introduction of accounting standard quite similar to IFRS, it became necessary to report compensation expense on the income statement. As a result, Japanese companies seem to be shifting their share compensation program from ordinary stock options to de facto restricted stocks; stock options with nominal strike price. Now about half of the stock options are restricted type stock options.

That fact reflects the ordinary stock option does not fit so well in Japanese business environment. When officers prefer to hold the shares, cost recognized by the company might exceed the gain felt by the officers. Ceilings for preferential tax treatment is set relatively low amount so the officers cannot make huge money from stock options. And more over there is relatively small difference between the executive compensation and ordinary employees' income. Most of the Japanese executives were ordinary employees when they were first employed by the company.

In Malaysia, almost 95% of the companies that comprise the Composite Index of the Bursa Malaysia had stock options plan for their employees. The Composite Index of Bursa Malaysia consists of 100 large companies. Unlike Japan, Malaysian companies do not have different type of stock options plan. This is because stock options plan as a reward system for employees is not popular among public listed companies in Malaysia. Unlike Japan, stock options plan by employers is mainly given to top executives of the company. Ordinary employees are given other incentives - better remuneration packages or bonus plans. The comparative analysis shows that there are many differences between Malaysia and Japan in respect to stock options reflecting the situation of the society and the business environment in each country.

ACKNOWLEDGEMENT

Financial support from the Japan Society for the Promotion of Science (JSPS) is gratefully acknowledged (Grant-in-Aid for Scientific Research (C) for FY2003 and FY2004 No.15530299, and from FY2005 to FY2007 No.17530336).

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Katsuyuki Yamashita, Otemon Gakuin University

Hajah Mustafa bin Mohd Hanefah, Universiti Sains Islam Malaysia

Akihiro Noguchi, Nagoya University
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Author:Yamashita, Katsuyuki; Hanefah, Hajah Mustafa bin Mohd; Noguchi, Akihiro
Publication:Journal of International Business Research
Geographic Code:9MALA
Date:Mar 1, 2010
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