THE EFFECT OF TAXES ON THE TIMING OF STOCK OPTION EXERCISE

This paper examines whether stock option exercise behavior is consistent with the incentives provided by the US Internal Revenue Code using data provided by a large multinational corporation which made multiple broad-based and management grants over the period of examination. In particular we examine whether holders delay exercising their options to transfer income from one year to the next, hence deferring the tax payments associated with the option gains. We document that taxpayers rationally delay the exercise of taxable nonqualified options around the end of the year, consistent with the incentive to delay tax payments. In contrast we do not find this pattern with respect to the exercise of qualified stock options, upon which taxes may be indefinitely deferred.