We estimate the relation between stock option (ESO) grants to the top five executives and future earnings to examine whether incentive alignment or rent extraction by top managers explains option granting behavior. The future operating income associated with a dollar of Black-Scholes value of an ESO grant is $3.71. To understand the source of these positive payoffs, we parse out ESO grant values into components predicted by economic determinants of option grants, governance quality, and a residual grant value. The payoffs to ESOs appear to be driven predominantly by the economic determinants of option grants and not poor governance quality.

Harris and Kemsley (J. Account. Res. (1999) 275) suggest that shareholder-level dividend taxes on retained earnings are fully impounded into stock prices at the top statutory rate. Harris and Kemsley base their empirical tests on Ohlson (Contemp. Account. Res. (1995) 661) with the addition of dividend taxes. We analyze Harris and Kemsley's extended Ohlson model and evidence. We show that the model, tests, and results in Harris and Kemsley are non-diagnostic regarding dividend tax capitalization.