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The Effects of Employee Stock Options on Credit Ratings
Yen - Jung Lee,
Georgia State University
ABSTRACT. This paper empirically examines the extent to which outstanding employee stock options (ESOs) impact credit ratings. I hypothesize that outstanding ESOs play two informational roles – suggesting equity infusion and predicting future repurchases – that help credit rating agencies evaluate the cash flow prospects of the issuing company. Consistent with both hypotheses, my results show that the present value of the expected cash proceeds and tax benefits from ESO exercise have favorable impacts on credit ratings while the present value of the expected cost of share repurchases needed to satisfy or undo ESO exercise has an unfavorable impact. The after-tax fair value of outstanding ESOs, which summarizes the effects of the above three ESO-related cash flows, is negatively associated with credit ratings and more so for companies with a tendency to engage in ESO-related repurchases.
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