Managerial Equity Holdings and Income Smoothing Incentives
49 Pages Posted: 20 Aug 2015 Last revised: 4 Mar 2017
Date Written: February 6, 2017
Abstract
Our study explores how managerial stock holdings and option holdings affect CEOs’ income smoothing incentives. Given the different roles of stock holdings and option holdings in solving agency problems, managers may smooth past earnings using discretionary accruals for the purpose of revealing information to help investors better predict future earnings, or alternatively, for the purpose of hiding volatility of past earnings. We find that the association between past smoothing and predictability of future earnings is increasing (decreasing) in CEO stock (option) holdings. The results are consistent with stock holdings aligning the interests of managers and shareholders, and managers using discretionary accruals to smooth past earnings to reveal information to investors about future performance. In contrast, option holdings have been linked with excessive risk-taking by managers, and managers use discretionary accruals to mask volatility of less predictable earnings. Thus, we provide evidence that income smoothing can be informative or opportunistic, depending on the incentives of CEOs.
Keywords: stock holdings; option holdings; executive compensation; income smoothing; earnings predictability; earnings management incentive
JEL Classification: G10; G32; M40; M41
Suggested Citation: Suggested Citation