Insurer Reserve Error and Executive Compensation

Abstract

This paper investigates the possibility that managers of insurance firms have an incentive to manipulate accounting results in order to maximize their total compensation. Insurance company executives are in a relatively unique position in that they may be able to manipulate their total compensation by exercising discretion in loss reserve practices. We find evidence that managers whose compensation packages are more bonus-laden are associated with larger loss reserve errors. We further find that managers who exercise options over the course of the year are positively related to under-reserving for incurred losses in the current and prior year. This is consistent with reserving practices of managers anticipating the exercising of options to maximize wealth.

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