Equity incentives and earnings management sage journals. Our results stand in contrast to the evidence in these studies regarding equity incentives and earnings management. We hypothesize that managers with high equity incentives are more likely to sell shares. Managements incentives to avoid negative earnings surprises.
This chapter briefly surveys a wide variety of popular legal earnings management techniques discussed in detail in later chapters. As a working theoretical representation, we assume that the use of equity compensation in the united states is endogenously determined within the broad legal, regulatory, and governance environment faced by u. The relation between equity incentives and earnings. Cfo and ceo equity incentives and earnings management. The directors choose whether to expend effort in designing an incentive contract for management, e, and if they do, they then determine the shape of the contract, s. This study aims to examine the effect of equity incentives on earnings management that occurs via the use of loan loss provisions by using a sample of 204 bankyear observations over the period 20062011. Such behavior would make sense for managers whose bonuslinked incentives are focused on meeting explicit targets for earnings. Equity incentives and corporate fraud in china springerlink. We find that in companies with higher ceo equity incentives, current year earnings are more informative of future earnings than in other companies. Introduction managers equity incentives has been widely used in management practice in every country. Equity incentives, earnings management, banking, regulation. Executive equity incentives, earnings management and. Incentive equity comes in many flavors, depending on the structure of the target and the funds prior customs. We measure equity incentives in a variety of ways and employ a battery of empirical tests.
Abstract prior studies that examine the effect of managerial incentives on investment or misreporting decisions typically hold firm characteristics constant and focus on a particular managerial incentive. Earnings management and equity incentive gap between ceos and cfos abstract extant research findings on the relative role of chief executive officers ceos and chief financial officers cfos in earnings management appear to be mixed jiang et al, 2010. Earnings management is the acceleration or deferral of expenses or revenue through operating or accounting practices with the objective to produce consistent growth in earnings. We hypothesize that managers with high equity incentives are more likely to sell shares in the future and this. On the other hand, equitybased compensation has been linked to many unintended consequences that can negatively affect shareholder value e. This paper examines the link between managers equity incentives arising from stockbased compensation and stock ownership and earnings management. Equity incentives and earnings management created date. As table 2 indicates, shareholders design the equity contract of the directors. Pdf the effect of directors equity incentives on earnings. The effect of equity incentives on earnings management and.
Outside directors likely face against finding a negative relation between outside directors equity incentives and earnings management, which we document in this study. Equity incentives is an effective way for firms to achieve the longterm incentive to the management. Thus, equitybased compensation serves as a governance mechanism and provides strong incentives for management to create value to shareholders. Earnings management involves the alteration of financial reports to mislead stakeholders about the organizations underlying performance, or to influence contractual outcomes that depend on reported accounting numbers. Ceo incentives and earnings prediction springerlink.
Previous research has shown that corporate fraud in china is a widespread phenomenon and has severe consequences for affected firms and executives. Additionally, in an earnings prediction setting, ceo incentives are shown to provide information about future. The findings in our study improve our understanding of how executive compensation affects auditors pricing decisions. Equity incentives and earnings management the accounting. We model the relationship between directors and management as a principalagent game with unobservable economic earnings. Next, we add earnings management proxy variables to investigate the association between earnings management and future managers insider trading. Matsumoto 2002 management s incentives to avoid negative earnings surprises. The effect of geographic location on the relation between ceo equity incentives and earnings management. Of course, mehran takes executive exposure to stock price as exogenous.
Earnings management and equity incentive gap between ceos and. The effect of geographic location on the relation between. Rank and file equity compensation and earnings management. Ceo equity incentives and audit fees by yongtae kim, haidan.
Longterm incentives longterm incentives are added to the mix to encourage the selection of longterm investments that increase value. Prior research suggests that sox is likely to have changed earnings management behavior cohen, dey, and lys, 2008. Sciencedirect journal of accounting and public policy. In the extant literature there is already a lot of research done on the subject earnings management. Several valuation models and regressions are used to measure the main proxies for executives compensation and the. To add this web app to the home screen open the browser option menu and tap on add to homescreen.
We examine the effect of geographic location on the relation between ceo equity incentives and earnings management for an unbalanced panel of 14,546 firmyear observations from 1992 to 20. Jan, 2014 the evidence suggests that auditors are concerned about ceos incentives to manage earnings because equity holdings tie ceos wealth to risk and cause ceos to be less riskaverse. Such behavior would make sense for managers whose bonuslinked incentives are focused on. The purpose of this paper is to examine this relation, thereby providing evidence that can be used to corroborate or refute allegations of equity incentiverelated earnings management. Accruals are components of earnings that are not reflected in current cash flows, and a great deal of managerial discretion goes into their construction. This study investigates whether information about chief executive officer ceo incentives is useful for predicting future earnings. Equity incentives, earnings management, discretionary accruals, insider trading. Effects of managerial incentives on earnings management. Effects of managerial incentives on earnings management ipedr. Request pdf the effect of trustees equity incentives on earnings management this study examines the effect of allowing directors to trade in a firms shares on the likelihood of earnings. Equity incentives and earnings management by qiang cheng. Managers equity incentives, arising from stockbased compensation and stockoption ownership, can induce earnings management in the hope of increasing stock prices and the value of their. On the other hand, there is some evidence that increasing managers equitybased incentives creates value.
Equity incentives and earnings management abstract this paper examines the link between managers equity incentives arising from stockbased compensation and stock ownership and earnings management. In addition to rollover equity, a fund will often set aside a pool for both existing and new management, with the same goal of aligning incentives. Or does earnings management exists in every company whether or not a variable. Additionally, in an earnings prediction setting, ceo incentives are shown to provide information about. The master thesis is dedicated first of all to our families for their encouragement, support and motivation all these years but also to members and. Abstract we compare executive equity incentives of firms accused of accounting fraud by the securities and exchange commission sec during the period 19962003 with two samples of firms not accused of fraud. We hypothesize that managers with high equity incentives are more likely to sell shares in the future and this motivates these managers to engage in earnings management to increase the value of the shares to be sold. This chapter briefly overviews and lists some of the most common techniques within each category. Besides, while studying the effect of equity incentive, most of the researchers have ignored the earnings management triggered by stock ownership incentive. Mehran 1995 finds that firm performance is positively related to the share of equity held by managers and the share of manager compensation that is equitybased.
Request pdf equity incentives and earnings management this paper examines the link between managers equity incentives arising from stockbased compensation and stock ownership and. Therefore the relation of equity incentives and earnings management can be understand better. Management equity incentives in private equity transactions. This paper explores how managers and supervisors equity incentives impact the likelihood of committing corporate fraud in chineselisted firms. This paper investigates whether executive wealth sensitivity to stock price fluctuations or executive equity transactions serve as incentives for earnings management. Equity incentives, opportunities, and earnings management using tax expense. Evidence from the banking industry we examine the relationship between equity incentives and earnings management in the banking industry. We find that the proximity of a companys headquarters to an urban area moderates the. The effect of geographic location on the relation between ceo.
Using stockbased compensation and stock ownership data over the 19932000 time period. The purpose of this paper is to examine this relation, thereby providing evidence that can be used to corroborate or refute allegations of equityincentiverelated earnings management. For example, equity incentives can entice managers to boost reported earnings just before they exercise options or sell stock. Ceo incentives and earnings management sciencedirect. Pdf managerial equity holdings and income smoothing.
This study provides empirical support for the agency theory of overvalued equity jensen. We find that ceo power over cfo does not actually have a significant effect on the involvement of cfos in earnings management. The effect of directors equity incentives on earnings management. Managers who sell shares in the future have earnings management incentives if two. Equity incentives, earnings management and insider trading. For their own trading gains, they determine the conditional. We hypothesize that managers with high equity incentives are more likely to sell shares in the future and this motivates these managers to engage in. Request pdf equity incentives and earnings management. Earnings management and manipulation by scott mcgregor. Keywords earnings management income smoothing financial reporting standards loan loss. An empirical study on the effects of equity incentive of.
Equity incentives and earnings management this paper examines the link between managers equity incentivesarising from stock. Equity incentives and stockba sed compensation are important features of the contracting en vironment between shareholders as represented by the board of directors and executives. We find no consistent evidence that executive equity incentives are associated with. More broadly, because earnings management using tax expense is a mechanism through which managers manipulate financial reports, we provide additional documentation about the relation between equity incentives and misreporting e. Keywords equity incentives, earnings management, firm performance 1. Modern corporations employ various mechanisms to remedy the adverse consequences. However, our understanding of the reasons that fraud is committed in a chinese. Some of these researches investigated the relation of earnings management with equity incentives. Studies examining equity offerings as an incentive for earnings management usually test whether managers manipulate earnings in periods prior to initial public. Equity incentives, opportunities, and earnings management. The effect of directors equity incentives on earnings. Our objective is to synthesize the broad literature on equity compensation and executive incentives. Those can include profits interests, options, phantom equity, restricted stock grants, and equity purchased with a.
Oct 26, 2003 this paper examines the link between managers equity incentives arising from stockbased compensation and stock ownership and earnings management. These incentives or events include, for example, the aim of maximizing of management compensations, inflating equity offer prices, safeguarding against the violation of debt agreements, and ensuring that anti. The evidence suggests that auditors are concerned about ceos incentives to manage earnings because equity holdings tie ceos wealth to risk and cause ceos to be less riskaverse. Ceo equitybased incentives and shareholder sayonpay in. A tool for earnings management a case study of the youngor group yuanyuan guo1, siqi lu2, joshua ronen3, jianfang jennifer ye2 abstract. Another cost of highpowered incentives is that they provide managers with incentives to manipulate the firms reported earnings e. Current earnings of an acquired company may be consolidated with parent company earningsproviding an automatic earnings boost if the subsidiary was purchased on favorable terms. We hypothesize that managers with high equity incentives are more likely to sell shares in the future and this motivates these managers to engage in earnings management to increase the value. An empirical study on the effects of equity incentive of the. Our study adds to the research on ceo equity compensation and earnings management by investigating their relationship across the entire distribution of earnings management using the quantile regression, which does not require the.
The third finding is that the relation between earnings management and equity incentives changes before and after the major accounting scandals and introduction of the sarbanes oxley act. By focusing on this regulated industry and using industryspecific earnings management proxies, we provide evidence on the impact of regulation on earnings management arising from chief executive officers equity incentives. This study investigates the variants of the jones 6 model and finds a significantly higher incidence of earnings management for firms with higher managers equity incentives. The effect of trustees equity incentives on earnings. I find that increasing wealth sensitivity, most notably the sensitivity arising from stock holdings, is associated with ceo abnormal accrual usage. Many companies use stock options to achieve this focus. Ceo equity incentives and audit fees by yongtae kim. Outside directors equitybased compensation and earnings.
I also find that managers with higher equity incentives or undertaking more aggressive earnings management are more likely to take large share selling in the following year and that effects are more pronounced for overvalued firms. For example, equity incentives can entice managers to boost reported. We consider two settings and utilize methodologies similar to those used in prior research that show an association between ceo equity incentives and earnings management. Equity incentives and earnings management request pdf. We hypothesize that managers with high equity incentives are more likely to sell shares in the future and this motivates these managers to engage in earnings management to increase the value of. Association of insider trading patterns with earnings management citations from 20022012. Is there a link between executive equity incentives and. Executive equity comepnsation and earnings management. Ceo variable remuneration and earnings management erasmus.
The most successful and widely used earnings management techniques can be classified into twelve categories. Cui, an empirical study on the effects of equity incentive of the listed corporations in the sme board of china an empirical analysis based on the view of earnings management, technology and investment, vol. This paper examines the link between managers equity incentivesarising from stock. Earnings management, in accounting, is the act of intentionally influencing the process of financial reporting to obtain some private gain. Earnings management and equity incentive gap between ceos.
May 20, 2012 this study investigates whether information about chief executive officer ceo incentives is useful for predicting future earnings. The findings in our study improve our understanding of how. Earnings management has a positive effect on earnings quality, and may weaken the credibility of financial reporting. These earnings may not reflect the underlying economics of the enterprise for the timeperiod. With chinas adoption of principalbased international accounting standards, companies now have discretion in how to account for the initial measurement, sale, and.
Integrating the earnings of the acquired company into corporate con solidated earnings. Hall and liebman 1998 and hall and murphy forthcoming provide evidence from samples of large u. Request pdf equity incentives and earnings management this paper examines the link between managers equity incentives arising from stock based. This paper takes the sme board companies which have implemented stock ownership incentive as the research. Earnings management and equity incentive gap between. In contrast to prior work that suggests equity incentives induce opportunistic managerial behavior, i find earnings management declines following the adoption of. We examine the relationship between equity incentives and earnings management in the banking industry.
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