Article2003

Stock Option Compensation and Earnings Management Incentives

Terry A. Baker · Denton L. Collins · Austin L. Reitenga

190 citations0/0 files storedJournal of Accounting Auditing & Finance

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Auditing, Earnings Management, Governance Corporate Finance and Governance Corporate Governance and Financial Management

Abstract

We examine whether the structure of executive compensation, specifically stock options relative to other forms of pay, is associated with opportunistic use of discretionary accruals in reported earnings. Prior research suggests that using options creates an incentive to temporarily depress the firm's stock price prior to the option award date, thereby lowering the exercise price of the options. We hypothesize, and find evidence, that relatively high option compensation is associated with income-decreasing discretionary accrual choices in periods leading up to option award dates. Furthermore, we find that this association is stronger when managers are able to publicly announce earnings prior to the option award date. Our results are consistent with the general implication from prior research that option compensation creates opportunistic incentives for managers to time the release of good and bad news to the market.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 1991Earnings Management During Import Relief Investigations 1985Positive Accounting Theory 1999Corporate governance, chief executive officer compensation, and firm performance 1997Earnings management to avoid earnings decreases and losses 2012Detecting Earnings Management 1985The effect of bonus schemes on accounting decisions 1994Debt covenant violation and manipulation of accruals

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2008Executive Stock Options, Missed Earnings Targets, and Earnings Management 2009Corporate Governance and Backdating of Executive Stock Options 2014CEO Overconfidence and Earnings Management During Shifting Regulatory Regimes 2009The Association between Management Earnings Forecast Errors and Accruals 2006Trading incentives to meet the analyst forecast 2010Corporate Governance and Accountability

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