Earnings Restatements, Changes in CEO Compensation, and Firm Performance

Posted: 10 Apr 2008 Last revised: 5 Mar 2014

See all articles by Qiang Cheng

Qiang Cheng

Singapore Management University

David B. Farber

Indiana University Kelley School of Business Indianapolis

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Abstract

Prior research finds that earnings restatements are linked to CEOs' excessive option-based compensation and equity holdings. In this paper, we investigate whether firms that experience earnings restatements recontract with their CEOs to reduce their option-based compensation and if so, whether this leads to improved firm performance. Based on 289 restatement firms over the period 1997-2001, we find that the proportion of CEOs' compensation in the form of options declines significantly in the two years following the restatement. Furthermore, we document that this reduction is accompanied by a decrease in the riskiness of investments, as reflected in lower stock return volatility and subsequent improvements in operating performance. Our results suggest that a decrease in option-based compensation reduces CEOs' incentives to take excessively risky investments, resulting in improved profitability. Overall, our findings provide insights into the design and efficacy of CEO compensation contracts.

Keywords: Earnings restatements, Stock options, CEO compensation, Operating performance

JEL Classification: G30, G32, J33, M41, M43

Suggested Citation

Cheng, Qiang and Farber, David B., Earnings Restatements, Changes in CEO Compensation, and Firm Performance. Accounting Review 83 (5): 1217-1250, September 2008. Available at SSRN: https://ssrn.com/abstract=1114647

Qiang Cheng (Contact Author)

Singapore Management University ( email )

60 Stamford Road
Singapore, 178900
Singapore

David B. Farber

Indiana University Kelley School of Business Indianapolis ( email )

801 W Michigan Ave
Indianapolis, IN 46202
United States

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