Stock option plans in Italy: does earnings management matter?

Many studies carried out on employee stock option plans state that the favourable accounting treatment, even if not declared, is often one of the main goals of this form of compensation. Looking at the practice, especially in the United States, it can be observed that the accounting issue is quite relevant. There is anecdotal evidence to suggest that companies could adverse the recognition of stock option plans for earnings management reasons. This can be also confirmed by the recent opposition that many high-tech companies expressed to the amendment of SFAS 123, which requires the recognition of share-based payments at the fair value measured at the grant date. The same accounting treatment has been chosen by IFRS 2, which has been already approved by the EU and has been applied to Italian consolidated financial statements starting from 2005. This paper aims at determining whether there is an association between the granting of employee stock option plans and the adoption of earnings management practices aimed at improving the profit during the years when plans are issued. Our investigation uses the “modified Jones model” on a sample of Italian listed companies to study earnings management behaviour. This analysis can make a preliminary contribution to assess whether recognition required by IFRS 2 will imply a future reduction in the granting of stock options as incentive means. In fact, this accounting standard not only gives rise to a change in earnings figures and corporate disclosure, but could also force entities to revise their employee incentive policies. In such a perspective, it is reasonable to assume that the shift to IFRS 2 will lead companies that in the past issued stock option plans essentially for earnings management reasons to lessen the use of employee stock options as a form of compensation.