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The threat of regulation is clear when proposed legislation is introduced in Congress or when other regulatory bodies formally begin consideration of new, tighter requirements. When faced with proposed undesirable regulation, firms may attempt to deflect it in a variety of ways. Accounting and economics research suggests that firms use accounting policy choice as a means of reducing political costs. Prior to 2002, only two firms voluntarily expensed stock options under the provisions of FASB 123. By the end of 2003, a number of firms volunteered to expense stock options in the face of possible mandates from the FASB. A close examination of the record of regulators’ activities indicates that, during 2002 and 2003, Congress proposed five pieces of legislation that would increase the tax costs of firms and six pieces of legislation that would increase the taxes of firm managers. We suggest that the decision to begin expensing options reflects firms’ and managers’ beliefs that the voluntary expensing of stock options for financial reporting purposes would ward off regulatory efforts to convert proposed tax legislation affecting the firms’ and managers’ taxes into enacted tax law. Our preliminary analysis provides evidence consistent with this general hypothesis. While prior research on the impact of taxes on accounting policy choice has examined accounting policy choice in response to enacted tax legislation, this paper provides early evidence on accounting policy choice in the face of proposed tax legislation.

Tax-related political costs and incentives to voluntarily expense stock options an analysis of the regulatory landscape