CHAPTER 1: INTRODUCTION 1.1 Background and Motivation
In the last few decades, it’s been fast grown executive compensation methods in Taiwan and all over the world, also it could be an important part of corporate governance. Especially stock-based compensation is the fastest-growing and traditionally has been used to align managerial interests with those of shareholders when separation of ownership and control causes agency problems1.
Employee stock ownership is the most common way for companies to motivate employees, to rally employees, and to maximize firm’s value and performance (Kruse, 1993;
Jones & Kato, 1995; Park & Song, 1995; Blasi, Conte & Kruse, 1996; Ichiniowski, Shaw &
Prennushi, 1997; Cui & Mark, 2002). Generally, there are two type of stock-based compensation used, Employee stock bonus and Employee stock options. From the perspective of corporate finance, the main difference between stock bonus and the employee stock options is the fact that the issue of stock bonus takes the post year performance as a standard, whereas the exercise of the ESOs depends on the future performance of the underlying shares. Furthermore, the issue of the ESOs implies the potential change in company ownership and capital structure, which has a large impact on the firm2. As say by Eberhard (2005), the ESOs are also important part of firm’s stage financing. Studies from initiation to until on the ESOs are not much as any other issues in finance because of gap of time, thus this topic attracted our attention for this study.
Employee Stock Options is a right to buy the underlying shares at a certain price over a specified period. It is issued by the firm for the salary compensation, remuneration and incentive scheme to the employees.
1 C.Jensen, H.Meckling 1976
2 Ling-Chu, Lee, Ming-Chun, Yang
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From previous studies, we can make main points of why do firms grant the Employee stock options? There are several reasons for that:
1. It aligns the interest of the employee with the interests of the shareholders.
2. Options are a form of compensation that is not taxable to the grantee and not deductable by the employer at the time the options are granted. It becomes taxable when the options are exercised.
3. Options don’t require a cash outlay by the company at the time of grant.
4. Stock options were not expensed against earnings before 2004 in the USA and before 2008 in Taiwan. It is now required for all grants of options to be valued at the time of grant and expensed when the options vest if the companies want to report GAAP earnings.
1.1.1 ESOs in the US and other countries
The first inception happened around 1990s’ in USA. Now, the granting of stock options by companies in the United States has become an increasingly more significant form of employee compensation. According to estimates by the National Center for Employee Ownership, over the last decade the number of employees eligible for stock options has grown from about one million to somewhere between seven and ten million. Even more striking is the trend toward offering stock options to all employees in a firm, not just the top managers. Core and Guay (2001) and Eberhart (2005) find that options are 6.9 percent and 12 percent of shares outstanding, respectively. The tendency to grant ESOs is not limited to solely to the US. Kato et al. (2005) and Ding and Sun (2001) present evidence of the widespread use of ESOs from Japan and Singapore, respectively. Japanese government statistics from 2004 indicate that nearly 1300 firms in Japan issued options; with 16 percent of firms with over 1000 number of employees has stock options plans.
In Australia, data collected from the Australian Stock Exchange (ASX) show share issued under employee plans as $1.4 ($2) billion Australian dollar for 1999 (2000). The
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exercise options on equities were $0.7 billion Australian dollar for 1999, representing up to 1 percent of the total compensation of employees in Australia. In China, the stock options are a fairy new practice. China allowed domestic companies to issue ESO in the beginning of 2006 and to foreign companies from 2008.
Until relatively recently, accounting for ESOs in the US and elsewhere was based on the 1972 Opinion No.25 of the Accounting Principles Board (APB 25). This standard required firms issuing fixed ESOs to record an expense equal to the difference between the market value of the shares on the grant date the option was granted to the employee (the grant date) and the exercise, or strike price of the option. This difference is called the intrinsic value of the option. Most firms granting ESOs set the exercise price equal to the grant data market value, so that intrinsic value is zero. As a result, no expense for ESOs compensation was recorded. For example, if the underlying share has a market value of 10USD on the grant date, setting the exercise price at 10USD triggers no expense recognition, whereas setting the exercise price at 8USD triggers an expense of 2USD per ESO granted.
On December 16, 2004, after much deliberation, consideration, public meetings and draft publications and pronouncements, the Financial Accounting Standards Board (FASB) published Statement of Financial Accounting Standards 123 (revised 2004), Share-Based Payment (FAS 123(R)). One of the reasons why the APB had not required fair value accounting for issue ESOs was the difficulty of establishing this value. This situation changed somewhat with the advent of the Black/Scholes option pricing formula. However several aspects of ESOs are not captured by Black Scholes. For example: the model assumes that options can be freely traded, where is ESOs cannot be exercised until the vesting date, which is typically one or more years after they are granted. Also, if the employee leaves the firm prior to vesting the options forfeited or, if exercised, there may be restrictions on the employee ability to sell the acquired shares. In addition, the Black/Scholes formula assumes that the options cannot be exercised prior to expiry (European option), whereas ESOs are (an
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American option) can be exercised prior to expiry. Nevertheless, it was felt by many that Black/Scholes provided a reasonable basis for estimation of ESO fair value. 2
Among the prior literatures related the performance of ESOs, Hall and Liebman (1998) finds that the compensation on CEOs can enhance the company’s performance; that is, change in the value of stocks and options owned by CEO help with the company’s performance. Core and Guay (2001) believes that the compensation plans of ESOs not only motivate employees but also improve corporate value. Sesil, Kroumova, Blasi, and Kruse (2002) suggest that the new economy firms (i.e. pharmaceuticals, software, semi-conductor and high-technology manufacturing fields) that issued ESOs always perform better. Ittner, Lambert and Larcker (2003) prove that new economy firms (i.e. computer, software, internet, telecommunications or networking fields) rely on ESOs compensation plans much more than do the companies of traditional sector, while performing better after ESO issuance. Frye (2004) indicates that a company that issued more ESOs delivers greater performance.
1.1.2 ESOs in Taiwan
Employee profit sharing has been practiced in Taiwan by United Microelectronics Corp (UMC) since 1983. Most of Taiwan’s listed firms used employee stock bonus as compensation package. As the stock bonus is gratuities and the actual value of the stock bonus is higher than the company’s earnings of the year, so shareholders’ interests could be conflict and share price could changeable due to increased numbers of outstanding shares.
Thus, in 2001 Taiwan’s Financial Supervisory Committee initiated the SFAS No39, Share based payment standard. It has imposed a cap on the employee stock bonus offered by companies raise pay to keep employees on and offer stock options (ESOs) for employees to subscribe so as to boost their performance. In Taiwan, ESOs are often dealt with by means of
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the issuance of new stocks, which is different from the method of share repurchases adopted by foreign countries to offer stock options for employees to subscribe.
Taiwan Semiconductor Manufacturing Co., the fabrication vice president said that:
“Salaries are low here, but the financial impact of the Chinese New Year bonus, yearly earnings stock bonuses and employee stock option plans can make the total package much higher than in the US”.
1.2 Objective and Proposed question of the study
This study examines the influence of firms’ specific characteristics, using such as financial indicators and ownership structure of public listed companies of Taiwan, on the decision of issuing ESOs. This research collects related data with ESO issuing companies of Taiwan from 2001 to 2009 obtains 14114 firm-years used for analyzes.
1.3 Structure of the study
The remainder of this study is organized as follows. Chapter two presents our proxies for the determinants of the firm-specific characteristics and the predicted relations between these variables and the issuance of ESOs. Our sample selection and the sources of our data are described in Chapter three. Chapter four presents the analysis and results, in the last Chapter five concludes the study.
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Figure 1- 1: Study procedure
Source: by this study
CHAPTER 2: LITERATURE REVIEW AND HYPOTHESISES