Impacts of Expensing Employee Bonus on Security Returns – A Study on Listed Firms in Taiwan Electronics Industry

The Legislative Yuan passed the amendment of Business Accounting Act on April 28, 2006, and FSC announced the related accounting rules for expensing employee bonus on August 28, 2008. With such revision, the employee bonus will be recognized as expense rather than earning distribution, and will be measured by fair value after January 1, 2008.
In this thesis, event study methodology was employed to investigate the reaction of security returns to the announcement of future accounting change for employee bonus; Event day 1 is defined as April 28, 2006, and event day 2 as August 28, 2006. Market model was adopted to estimate abnormal returns (AR), and cumulative abnormal returns (CAR) during the event periods. A regression model was also introduced to explore the correlation between CAR and firm’s characteristic factors: EPS change rate, employee stock bonus ratio, natural logarithm of total assets, GDR (dummy variable), holding percentage of foreign investors, and price change rate.
The empirical results could be summarized as follows:
1. The average CAR event period 1 is -6.34%, and -0.99% for event period 2; both CAR’s are negative, and meet 1% significance level. Such empirical result implies that expensing employee bonus will have negative impact on security returns.
2. EPS does drop if the employee bonus is recognized as expense in stead of earning distribution. On the average, EPS will decease 8.58% with 9.82% standard deviation for the firms investigated. According to the empirical result, if EPS decreases by 1%, the point estimation of CAR will drop by 0.1612%, providing other things being equal.
3. Employee bonus is allocated from a firm’s after tax earning, and the amount is fixed. The number of bonus stock shares will be calculated by the market value rather than face value after expensing employee bonus. Besides, market value, in general, is higher than face value. Therefore, the allocated shares for employees will become less; so will the total outstanding shares. If the firm’s value keeps the same, the stock price will increase with less total outstanding shares. The empirical result indicates the stock price changing ratio is positively correlated to CAR.
4. The companies which have issued Global Depositary Receipt (GDR) should recognize the employee bonus as expense according to the international GAAP. Their final reports should have revealed the impact of expensing employee bonus; therefore, the impact of expensing employee bonus to these firms should be less. The empirical result meets our expectation.
5. The relationship of CAR and stock bonus ratio migrates from negatively correlated in event period 1 to positively correlated in event period 2. This implies dilution effect is greater than motivation effect in event period 1; however, motivation effect is more pronounced than dilution effect in event period 2.