Employee stock options and pro forma earnings management

Effective in 1996, FAS 123 established new financial reporting requirements for employee stock options. This study extends previous research that suggests that opposition to FAS 123 was politically motivated and that options have been used to manage earnings. We find strong evidence that reported option values under FAS 123 are influenced by various financial reporting costs of the firm, including political costs related to executive pay. The results appear to be consistent with previous research regarding the effects of political considerations and earnings management strategies on the use and disclosure of employee options.