TAILIEUCHUNG - Tax Deductibility of Employee Stock Options

Congress likely would find itself embroiled in any such financial crisis through its direct role in conducting fiscal policy and in its indirect role in the conduct of monetary policy through its supervisory responsibility over the Federal Reserve. Such a coordinated withdrawal seems highly unlikely, particularly since the vast majority of the investors are private entities that presumably would find it difficult to coordinate a withdrawal. The financial crisis and economic downturn, however, have sharply reduced the value of the assets foreign investors acquired, which may make them more hesitant in the future to invest in certain types of securities | Tax Deductibility of Employee Stock Options Amin Mawani KEYWORDS employee stock option plans executive compensation phantom shares tax deductions accounting CONTENTS Motivation for Using Employee Stock Options 1230 Aligning Incentives Between Employees and Shareholders 1232 Subjective Value of Stock Options to Employees 1233 Hedges and Monetization of Employee Stock Options 1234 Stock Options Versus Shares 1237 Preserving Corporate Cash Flows 1238 Avoiding Reduction of Book Profits 1244 Denial of Tax Deduction for Employee Stock Options 1248 Income Tax Versus Financial Reporting Cost Tradeoffs 1255 Book-Tax Conformity 1256 Tax Revenue Implications of Allowing a Deduction for Employee Stock Options 1257 Conclusion 1258 MOTIVATION FOR USING EMPLOYEE STOCK OPTIONS Employee stock options are complex instruments that have grown in popularity for many reasons including their potential for aligning incentives between shareholders and managers. However the efficacy of employee stock options is increasingly being questioned. In recent times many senior executives have accumulated substantial wealth from stock options as their companies have floundered by both accounting and stock market measures. 1 The side effects and unintended consequences of Of the Schulich School of Business York University Toronto. A research grant from the Social Sciences Humanities Research Council of Canada is gratefully acknowledged. 1 For example the 2000 Management Information Circular of Nortel Networks Corporation reveals that John Roth former chief executive officer exercised options to earn 135 million in 2000 just before the company s share price dropped drastically. 1230 2003 vol. 51 No 3 tax deductibility of employee stock options 1231 employee stock options are increasingly being articulated with a call by academics and corporate governance experts for recognition of the cost of stock options granted as an expense in the financial statements. If corporations are forced to acknowledge the

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