Managerial Incentives and Corporate Fraud: The Sources of Incentives Matter

Abstract:     
Operating and stock return results imply that managers that commit fraud likely anticipate large stock price declines if they do not misreport earnings. Stock price declines cause greater losses for managerial stockholdings than for option holdings because of differences in payoff convexity. Fraud firms have significantly greater incentives from unrestricted stockholdings than control firms do, and unrestricted stockholdings are the largest source of incentives at fraud firms. Collectively, these results emphasize the importance of the shape and vesting status of managerial incentive payoffs in providing incentives to commit fraud. Fraud firms also have characteristics that suggest a lower likelihood of fraud detection, which implies lower expected costs of fraud. Overall, the results are consistent with the economic theory of crime.

Keywords: corporate fraud, incentives, stock options, executive compensation, governance

JEL Classifications: G34, K22, M41, J33

Working Paper Series