Does Equity-Based Compensation Really Have a 'Dark Side'? The Influence of Regulatory Discretion

Abstract

Using a recent sample of firms subject to SEC litigations for fraud and employing a detection-controlled estimation technique, we find that equity-based executive compensation (EBC) is positively related to both the probability of fraud commission and the probability of being prosecuted by the SEC. Moreover, EBC usage significantly decreased post Sarbanes-Oxley (SOX), but only in high-growth industries. Finally, post SOX, fraud commission dramatically declined by 60-70%, and this appears to be driven by the increased fraud penalties in SOX. These empirical results highlight the influence of potential regulatory discretion on fraud commission, fraud detection, and the usage of EBC.

Keywords: Equity-Based Compensation, Regulatory Discretion, Fraud, Sarbanes-Oxley

JEL Classification: G38, J33