• Selected
• Entire List

Abstract:
This paper traces the development of archival, microeconomic-based, empirical income tax research in accounting over the last fifteen years. The paper details three major areas of research: (i) the coordination of tax and non-tax factors, (ii) the effects of taxes on asset prices and (iii) the taxation of multijurisdictional (international and interstate) commerce. Methodological concerns of particular interest to this field also are discussed. The paper concludes with a discussion of possible directions for future research.

Abstract:
This paper traces the development of archival, microeconomic-based, empirical income tax research in accounting over the last fifteen years. The paper details three major areas of research: (i) the coordination of tax and non-tax factors, (ii) the effects of taxes on asset prices and (iii) the taxation of multijurisdictional (international and interstate) commerce. Methodological concerns of particular interest to this field also are discussed. The paper concludes with a discussion of possible directions for future research.

Abstract:
We estimate the relation between top 5 executive stock option (ESO) grants 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 $3.82. To understand the source of these positive payoffs, we parse out ESO grant value 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 ESO grants and not poor governance quality. Thus we find little evidence in support of rent extraction.

management compensation, stock options, incentive alignment, rent extraction

Abstract:
This paper explains firm disclosures of the tax benefits of employee stock options and discusses the implications of this disclosure for academic research studies and financial statement users. We do this in order to show that there are important implications for empirical research studies and inferences regarding tax burdens. The effects of this accounting have not often been taken into account in empirical research yet it may impact the inferences made from the studies. We find that firm disclosures are not always clear as to the amount of the corporate tax benefits from the exercise of stock options. In addition, in many cases, firms' reported effective tax rates are overstated as are estimates of marginal tax rates and tax burdens using financial statement disclosures. This study is important because it explains the accounting for the tax benefits of stock options, describes the problems this accounting may cause in empirical studies and for financial statement users, and provides some suggestions on adjusting for this accounting to more correctly estimate tax rates and burdens.

Employee stock options, Tax benefits, Effective tax rates, Marginal tax rate

Abstract:
We examine whether executive stock options (ESOs) provide managers with incentives to invest in risky projects. For a sample of oil and gas producers, we examine whether the coefficient of variation of future cash flows from exploration activity (our proxy for exploration risk) increases with the sensitivity of the value of the CEO's options to stock return volatility (ESO risk incentives). Both ESO risk incentives and exploration risk are treated as endogenous variables by adopting a simultaneous equations approach. We find evidence that ESO risk incentives has a positive relation with future exploration risk taking. Additional tests indicate that ESO risk incentives exhibit a negative relation with oil price hedging in a system of equations where ESO risk incentives and hedging are allowed to be endogenously determined. Overall, our results are consistent with ESOs providing managers with incentives to mitigate risk-related incentive problems.

Abstract:
We examine whether executive stock options (ESO) encourage managers to make risky investments on behalf of shareholders. For a sample of oil and gas producers, we find, as predicted, that the variance of cash flows from exploration activity and the extent of price risk exposure hedged are positively associated with the sensitivity of CEO's options to equity risk. Thus, ESOs appear to motivate managers to take on exploration risk. Moreover, ESOs appear to induce CEOs to hedge oil price risk to avoid under-investment in exploration projects.

Abstract:
We demonstrate that the effect of special items on the time-series of seasonally-differenced quarterly earnings differs from the effect of other components of earnings. Focusing on earnings four quarters subsequent to the special item where the time-series differences are most pronounced, we also demonstrate that market expectations of earnings impounded in prices reflect these time-series differences. Further, our estimates suggest that the proportion of the time-series implications of special items impounded in prices is larger than the proportion for other, non-special items, components of earnings. Nonetheless, market prices do not fully reflect time-series implications of special items ? a significant proportion of the time-series implications of negative special items is not impounded in prices and past values of special items predict subsequent abnormal returns.

Abstract:
Harris and Kemsley (1999) 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 (1995) 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.

Valuation, dividend taxes, tax capitalization

Abstract:
Recent evidence and statements in Harris and Kemsley (1999) suggests that shareholder-level dividend taxes on retained earnings are fully impounded at the top statutory rate into stock prices. We re-examine these claims and results. Using the traditional definition of dividend tax capitalization, that asset prices will be lower if the asset returns are subject to higher taxation, we reject the claim that the valuation of retained earnings is reduced because it is subject to future taxes when distributed as dividends. Harris and Kemsley base their predictions and empirical tests on Ohlson (1995). We offer alternative formulations and interpretations of the role of contributed capital, retained earnings, and earnings in the Ohlson (1995) model. Our evidence does not reject dividend tax capitalization but does reject full dividend tax capitalization on retained earnings arising from future dividends being paid from the current stock of retained earnings. We also investigate the crucial role of the ratio of retained earnings to book value in Harris and Kemsley (1999) and report some results inconsistent with their interpretation of dividend taxes on retained earnings.

Abstract:
Sloan (1996) and several follow up papers show that the stock market behaves as though it cannot understand the implications of accruals for future earnings. We propose and find evidence consistent with the hypothesis that risk-averse arbitrageurs are unable to eliminate accrual related mispricing because individual stocks in the extreme accrual deciles do not have close substitutes. Note that the textbook theory of arbitrage is predicated on the ability of the arbitrageur to find perfect substitutes for mispriced stocks. Our results suggest that arbitrage risk impedes arbitrageurs from eliminating accrual mispricing.

Accrual anomaly, arbitrage risk

Abstract:
Although leading indicators are becoming increasingly important for equity valuation, disclosures of such indicators suffer from the absence of GAAP related guidance on content and presentation. We explicitly examine (i) whether one leading indicator - order backlog - predicts future earnings, and (ii) whether market participants correctly incorporate such predictive ability in determining share prices. We find that the stock market overweights the contribution of order backlog in predicting future earnings and a hedge strategy that exploits such overweighting generates significant future abnormal returns. However, such mispricing is not due to analysts' inability to incorporate order backlog into their earnings forecasts.

Abstract:
A number of recent studies assume market efficiency and hence interpret an association between stock returns and leading indicators as evidence of the contribution of such indicators to future earnings. We explicitly examine (i) whether one leading indicator - order backlog - has predictive ability for future earnings, and (ii) whether market participants correctly incorporate such predictive ability in determining share prices. We find that the stock market overweights the contribution of order backlog in predicting future earnings and a hedge strategy that takes positions on the cross-sectional distribution of backlog generates significant future abnormal returns. Additional analysis indicates that the market mispricing is not due to analysts' inability to incorporate order backlog into their earnings forecasts.

Abstract:
A distinctive feature of stock options is that they create incentives for managers to take risks. For a sample of 6,439 CEO-year observations over 1992-1999, we find that risk-taking incentives offered by CEO's stock options (the sensitivity of ESO values to stock return volatility) are statistically associated with greater risk-taking behavior as proxied by one-year ahead stock return volatility. However, the economic magnitude of such option-induced risk taking on the CEO's wealth is relatively modest. Our tests of the performance consequences of option-induced risk taking incentives are specification-dependent and do not exhibit consistent results. Hence, we cannot unambiguously conclude that the increased risk taking results in improved future operating performance.

Abstract:
We gather data from 77 current mid-level managers and 111 future entry-level managers, to investigate how they value stock options and restricted stock. We refer to our current and future manager groups collectively as "managers." We supplement our manager data with a dozen field interviews with senior executives. We find that managers, on average, systematically overvalue stock options relative to both the Black-Scholes (B-S) value and fair-value equivalent restricted stock grants. Thus, contrary to conventional economic thinking, many risk-averse agents do not appear to discount B-S values of options. Further, in valuing options, managers value quick vesting and extended expiration. Managers also extrapolate recently rising stock price trends to arrive at their subjective valuations of both options and restricted stock. In general, our results suggest that a combination of economic, behavioral and demographic factors explain managers' subjective valuations of options and restricted stock.

stock options, restricted stock, managers

Abstract:
We examine the association between accounting restatements and the pricing of information risk. Using the Fama and French three-factor model augmented with an information risk factor we find a significant increase in the factor loadings on the information risk factor for restatement firms after a restatement announcement. We find that the increase is related to the discretionary component of information risk and associated with the short-window price reaction to restatements. We study several potential determinants of the change in information risk pricing and find evidence consistent with the restatement reason, restatement initiator and number of times a firm restates affecting the change in the pricing of information risk. We also find an increase, of smaller magnitude, in the pricing of information risk for non-restatement firms in the same industries as the restatement firms consistent with an information transfer effect.

restatements, information risk, earnings quality, cost of capital

Abstract:
Although agency theory suggests that firms ought to index executive compensation to remove market-wide effects (i.e., RPE), there is little evidence to support this theory. Oyer (2004) posits that absence of RPE is optimal if the CEO's reservation wages from outside employment opportunities rise and fall with the economy's fortunes. We directly test and find support for Oyer's (2004) theory. We argue that the CEO's outside opportunities depend on his talent proxied by the CEO's financial press visibility and his firm's recent industry-adjusted ROA. Our results are robust to alternate explanations such as managerial skimming, oligopoly and asymmetric benchmarking.

Compensation, Relative Performance Evaluation, talent

Abstract:
Although agency theory suggests that firms ought to index executive compensation to remove market-wide effects (i.e., RPE), there is little evidence to support this theory. Oyer (2004) posits that absence of RPE is optimal if the CEO's reservation wages from outside employment opportunities rise and fall with the economy's fortunes. We directly test and find support for Oyer's (2004) theory. We argue that the CEO's outside opportunities depend on his talent proxied by the CEO's financial press visibility and his firm's recent industry-adjusted ROA. Our results are robust to alternate explanations such as managerial skimming, oligopoly and asymmetric benchmarking.

Abstract:
We examine whether the information content of earnings is inversely related to the degree of conformity between financial accounting income and taxable income. Our inquiry exploits a natural experiment first examined by Guenther et al. (1997) in which a set of U.S. firms were forced to increase their book-tax conformity as a result of a change in the tax law. We find evidence consistent with the increase in book-tax conformity reducing the usefulness of financial accounting earnings. The information content of earnings as measured by the long-window earnings response coefficients and the R-squared from a regression of returns on earnings decreases for this set of firms after the tax law required greater book-tax conformity. We find that the declines are significantly larger than the changes in the same measures for an industry-matched sample of firms not required to increase conformity. These results add to the academic literature on the interaction of taxes and financial reporting as well as to the policy debate about whether the U.S. should conform the tax law to GAAP, a debate that has recently intensified.

book-tax conformity, information content

Abstract:
We examine whether accrual earnings quality is a priced information risk factor in a dividend change setting. We define information risk as the probability that firm-specific financial statement information pertinent to investor pricing decisions is of low precision, and use the factor-mimicking portfolio returns formed on the Dechow-Dichev (2002) AQ metric to proxy for the Information Risk (IR) factor returns. We augment the Fama-French three-factor model with this IR factor, and find that dividend initiation and increase firms exhibit a decrease in the factor loadings on the IR factor while dividend decrease firms exhibit an increase in the corresponding factor loadings, and such changes in the factor loadings occur months prior to the dividend change announcements. Further analysis indicates that dividend initiation and increase (decrease) firms experience a corresponding improvement (decrease) in the precision of earnings information (proxied by changes in the AQ metric) and a reduction (an increase) in analyst forecast dispersion and stock return volatility in the years surrounding the structural break on the IR factor loadings. Overall, our results are consistent with investors treating the information risk associated with the precision of financial statement information as a priced risk factor, with both the precision and pricing changing in predictable directions around dividend changes.

Dividends, information risk, accruals quality, systematic risk

Abstract:
Recent corporate accounting reporting scandals and aggressive corporate tax shelters have led for calls for regulatory reform. One such call is to conform (or reduce the gap between) the calculation of book and taxable income. Proponents of conformity focus on perceived benefits while ignoring possible costs. We examine one possible cost: the loss in information content to investors if one measure is removed from the information set. We provide evidence on this possible loss by examining the relative and incremental information content over the past 20 years of book and (estimated) taxable income for a large sample of firms. We find book income exhibits significantly greater relative explanatory power while both exhibit significant incremental explanatory power. Conforming the two measures at a minimum results in the loss of incremental explanatory power and if book income is conformed to the tax rules, an estimated 50% loss in the explanatory power of earnings.

Book-tax conformity, information content, taxable income, book income

Abstract:
This paper investigates whether dividends are informative about a firm's future earnings. We examine this issue by investigating the association between current year stock returns and current and future earnings for firms that pay dividends in the current year as compared to firms that do not pay dividends. The data reveal that relative to non-dividend paying firms, dividend paying firms have current returns that are more associated with future earnings. In addition, we report results consistent with the market having a better understanding of a firm's future earnings after a dividend initiation relative to before. Overall, our results are consistent with dividends providing relevant information about future earnings to the market that is not in current earnings and that this information is incorporated into stock price.

Dividends, Information Content, Earnings

Abstract:
In a recent working paper, Plesko (1999) uses confidential tax return data to evaluate alternative measures of corporate average and marginal tax rates and concludes "The results suggest that commonly used measures of average tax rates provide little insight about annual corporate tax burdens, and may introduce substantial bias into statistical models. Marginal tax rate proxies perform better, but there appears to be little, if any, empirical value added by methods that go beyond easily constructed measures traditionally used in the literature." I caution readers in accepting the above inferences because of conceptual flaws in Plesko's evaluation. In evaluating financial statement based average tax rates, Plesko assumes researchers are attempting to estimate statutory tax burdens (tax payable as a percent of taxable income) whereas I would argue that most researchers are attempting to examine a more general concept of corporate tax burdens (tax payable as a percent of book income). Which tax burden is appropriate depends on the research question but Plesko assumes the statutory tax burden is always the appropriate measure. In evaluating financial statement based marginal tax rates, Plesko uses a single period measure which fails to take into account the effects of carryback and carryforward rules in calculating taxable income. Thus his marginal tax rate benchmark is flawed.

Abstract:
This paper investigates why CFOs become involved in material accounting manipulations. To address this question, we examine various costs and benefits for CFOs who are associated with the manipulations in order to test two explanations: (i) CFOs instigate the earnings manipulations for immediate personal financial benefit, versus (ii) CFOs acquiesce to CEOs’ pressure to manipulate earnings. Consistent with CFOs being acquiescent, we find that CFOs bear higher litigation cost yet reap less financial benefit than CEOs using a comprehensive sample of material accounting manipulations disclosed between 1982 and 2005. CFOs are more likely to be charged by the SEC for accounting manipulations than CEOs. Regarding financial benefit, while CEOs of manipulation firms have higher pay-for-performance sensitivity than CEOs of matched non-manipulating firms, CFOs of manipulating firms have similar pay-for-performance sensitivity to other non-CEO executives of manipulating firms and to CFOs of the matched firms. Moreover, we find that accounting manipulations are more likely when CEO power is high. Finally, our AAER context analyses suggest that CEOs of manipulation firms are more likely than CFOs to be described to have orchestrated the manipulation and to be ordered to disgorge financial gains from the manipulation. Taken together, our findings are consistent with the explanation that CFOs are involved in material accounting manipulations because they succumb to CEO pressure, rather than because they seek immediate personal financial benefit.

earnings quality, accounting manipulation, CFO turnover, CEO power, incentive compensation

Abstract:
Taxes represent a significant cost to the firm and shareholders, and it is generally expected that shareholders prefer tax aggressiveness. However, this argument ignores potential non-tax costs that can accompany tax aggressiveness, especially those arising from agency problems. Firms owned/run by founding family members are characterized by a unique agency conflict between dominant and small shareholders. Using multiple measures to capture tax aggressiveness and founding family presence, we find that family firms are less tax aggressive than their non-family counterparts, ceteris paribus. This result suggests that family owners are willing to forgo tax benefits in order to avoid the non-tax cost of a potential price discount, which can arise from minority shareholders' concern with family rent-seeking masked by tax avoidance activities (Desai and Dharmapala 2006). This inference is further strengthened by our finding that family firms without long-term institutional investors (as outside monitors) and family firms expecting to raise capital exhibit even lower tax aggressiveness. Our result is also consistent with family owners being more concerned with the potential penalty and reputation damage from an IRS audit than non-family firms. We obtain similar inferences when using a small sample of tax shelter cases.

family firm, tax aggressiveness, entrenchment

Abstract:
Using data from a survey of tax executives, we examine the corporate response to the one-time dividends received deduction in the American Jobs Creation Act of 2004 (AJCA). We describe the firms' reported sources and uses of the cash repatriated under the Act. In addition, we examine non-tax costs companies incurred rather than bringing the cash home prior to the AJCA. We also contribute to current policy debates by examining whether firms would repatriate reinvested earnings again if a similar Act were to occur in the future and the likelihood that firms assess on there being another such Act. Overall, the evidence is consistent with a substantial lockout effect resulting from the current U.S. tax policy of taxing the worldwide profits of U.S. multinationals.

repatriation, tax, American Jobs Creation Act, Homeland Investment Act, dividends received deduction, trapped equity, international tax, trapped cash, Section 965, stimulus, tax amnesty

Abstract:
We analyze survey responses of nearly 600 tax executives to better understand decisions related to location of operations, reinvestment, and profit repatriation. Prior literature does not examine how these decisions are affected by the ability to avoid recording for financial reporting purposes the U.S. income tax expense on foreign earnings. Our evidence indicates that avoiding financial accounting expense is an important influence on decisions about where firms locate operations, as well as whether to reinvest or repatriate foreign earnings. Indeed, the importance of avoiding expense recognition is statistically indistinguishable from the importance of avoiding real, cash taxes. This result is important in light of the decades of research on location and repatriation decisions that examines cash tax implications but has heretofore not investigated the importance of financial reporting effects. Our analysis suggests that financial reporting considerations could be one cause of "trapped" equity and high foreign cash holdings.

investment, reinvestment, repatriation, tax expense, multinational, tax policy, tax stimulus, tax reform

Abstract:
This paper discusses the issues surrounding the proposals to conform financial accounting income and taxable income. The two incomes diverged in the late 1990s with financial accounting income becoming increasingly greater than taxable income through the year 2000. While the cause of this divergence is not known for certain, many suspect that it is the result of earnings management for financial accounting and/or the tax sheltering of corporate income. Our paper outlines the potential costs and benefits of one of the proposed "fixes" to the divergence: the conforming of the two incomes into one measure. We review relevant research that sheds light on the issues surrounding conformity both in the U.S. as well as evidence from other countries that have more closely aligned book and taxable incomes. The extant empirical literature reveals that it is unlikely that conforming the incomes will reduce the amount of tax sheltering by corporations and that having only one measure of income will result in a loss of information to the capital markets.

Abstract:
We examine whether accrual earnings quality is a priced information risk factor in a dividend change setting. We define information risk as the probability that firm-specific financial statement information pertinent to investor pricing decisions is of low precision, and use the factor-mimicking portfolio returns formed on the Dechow-Dichev [2002] accrual quality (AQ) metric to proxy for the information risk (IR) factor returns. We augment the Fama-French three-factor model with this IR factor, and find that dividend initiation and increase firms exhibit a decrease in the factor loadings on the IR factor while dividend decrease firms exhibit an increase in the corresponding factor loadings, but such changes in the factor loadings occur months prior to the dividend change announcements. The results are robust to further controls for operating risk and using an alternative measure of information risk. Further analysis on changes in information characteristics such as AQ, the probability of informed trading score (PIN), forecast dispersion, and return volatility surrounding dividend change events are consistent with the asset pricing results. Overall, we interpret our results as being consistent with investors treating the information risk associated with the precision of financial statement information as a priced risk factor, with both the precision and pricing changing in predictable directions around dividend changes. However, while we attempt to control for operating risk changes in additional tests, we cannot completely rule out changes in operating risk as a competing alternative explanation for our observed results.

Abstract:
We conduct a field survey to investigate whether current mid-level and future entry-level managers (collectively managers) subjectively value stock options and restricted stock consistent with economic theory. We find that managers, on average, subjectively value stock options at greater than their Black-Scholes value and greater than fair-value equivalent restricted stock. This result contrasts with conventional economic wisdom that risk-averse employees discount the Black-Scholes value of an option. With respect to stock options, our results also reveal that managers, on average, have a lottery ticket mentality when subjectively valuing options, they value shorter vesting periods, and they value longer terms to maturity. With respect to stock options and restricted stock, we find that managers tend to extrapolate recently rising stock price trends to arrive at their subjective values. Overall, our results suggest that in some cases standard economic theory does not accurately reflect how managers appear to subjectively value stock options and restricted stock.

Stock options, Restricted stock, Managers' subjective values, Black-Scholes model

Abstract:
Increasing the conformity between accounting earnings and taxable income has been proposed to improve financial reporting and curtail aggressive tax planning. We find, however, that increasing conformity results in earnings that are less informative. Our inquiry exploits a unique sample of firms forced to change from the cash method to the accrual method for tax purposes, thereby increasing their book-tax conformity. We find that these firms experienced a decrease in earnings informativeness compared to control firms unaffected by the change. To our knowledge this is the first evidence of tax law changes affecting the informativeness of accounting earnings.

book-tax conformity, earnings informativeness

Abstract:
We show that the accrual anomaly documented by Sloan (1996) is concentrated in firms with high idiosyncratic stock return volatility making it risky for risk-averse arbitrageurs to take positions in stocks with extreme accruals. Moreover, the accrual anomaly is found in low price and low volume stocks, suggesting that transaction costs impose further barriers to exploiting accrual mispricing.

Capital markets, accrual anomaly, arbitrage, idiosyncratic risk, transaction costs

Abstract:
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.

management compensation, stock options, incentive alignment, rent extraction

Abstract:
We examine whether managers adjust LIFO inventories, other current accruals, and depreciation consistent with the objective of minimizing taxes, debt-related costs, costs of foregoing smoothed earnings, and adjustment costs. Our findings indicate long-time LIFO users on average manage inventories to smooth earnings and reduce debt costs and manage current accruals to smooth earnings and lower taxes. Unlike earlier studies we do not find strong evidence of year-end inventory management to increase LIFO tax savings. Our findings also indicate previous period accruals, contemporaneous operating cash flows, and operating cycle length influence current period accruals' predetermined levels and adjustment costs.

Abstract:
We examine whether managers adjust LIFO inventories other current accruals and depreciation consistent with the objective of minimizing taxes debt-related costs costs of foregoing smoothed earnings and adjustment costs. Our findings indicate long-time LIFO users on average manage inventories to smooth earnings and reduce debt costs and manage current accruals to smooth earnings and lower taxes. Unlike earlier studies we do not find strong evidence of year-end inventory management to increase LIFO tax savings. Our findings also indicate previous period accruals contemporaneous operating cash flows and operating cycle length influence current period accruals' predetermined levels and adjustment costs.

Abstract:
Manufacturing firms can manipulate income by producing in excess of the quantity needed to meet current period demand, thereby allocating part of current period fixed manufacturing overhead costs from cost of goods sold to inventory. Since it is subject to manipulation, the component of earnings due to producing in excess of sales may be of lower quality than the remaining component of earnings. We investigate this possibility using a regression of security returns on unexpected income and an estimate of the change in percent of production added to inventory (CPAI). An analytical model indicates that CPAI determines the "earnings surprise" subject to manipulation by overproducing. Assuming the market recognizes this, the coefficient on CPAI should be negative since this low quality component must be deducted from the total "good news" conveyed by the change in reported earnings. Alternatively, CPAI may convey good or bad news to the market that is unrelated to the manipulation of current period earnings. Firms may increase the percent of production added to inventory in anticipation of high levels of future sales. In this case, the estimated coefficient on CPAI should be positive. Or if the increase in the percent of production added to inventory reflects anticipation of a strike or an unexpected downturn in current sales, the estimated coefficient should be negative. Cross-sectional tests using a large sample of manufacturing firms indicate a significant positive relation between security returns and CPAI. This is consistent with market participants viewing CPAI as a leading indicator of firm performance. While the results are most supportive of CPAI conveying good news, there is some evidence that CPAI is used by managers to smooth earnings and, for firms classified as smoothing earnings, there is weak evidence that the component of earnings related to CPAI is viewed by market participants to be of lower quality.

Abstract:
This paper examines the decision to exercise employee stock options (ESOs). Our results indicate a positive relation between the extent of "early" exercise and the unhedged risk of the option. Specifically we document a positive relation between the variance of ESO returns and the extent of "early" exercise and show that the strength of the relation is reduced by the extent the firm hedges the returns on the ESO. We thus provide empirical evidence of a link between an ESO's expected term and its investment risk to the executive and document that some firms provide a hedge against option risk.

Abstract:
This paper examines the decision to exercise employee stock options (ESOs). Our results indicate a positive relation between the extent of "early" exercise and the unhedged risk of the option. Specifically we document a positive relation between the variance of ESO returns and the extent of "early" exercise and show that the strength of the relation is reduced by the extent the firm hedges the returns on the ESO. We thus provide empirical evidence of a link between an ESO's expected term and its investment risk to the executive and document that some firms provide a hedge against option risk.