Rank and File Equity Compensation and Earnings Management: Economic incentives and the Robin Hood Effect

63 Pages Posted: 1 Jul 2016 Last revised: 8 Aug 2018

See all articles by Kip Holderness

Kip Holderness

West Virginia University

Adrienna A. Huffman

The Brattle Group

Melissa F. Lewis-Western

Brigham Young University - Marriott School of Business

Date Written: May 9, 2018

Abstract

The wide-spread use of rank and file equity-based compensation suggests that executives believe that rank and file employees can affect firm outcomes, and some research supports this view. If equity-based incentives influence rank and file employees’ productive efforts, they might also influence rank and file employees’ earnings management decisions as extant literature provides evidence that equity-based compensation creates earnings management incentives (economic incentive effect). Rank and file equity-based compensation may also influence executives’ earnings management decisions as psychology research suggests that individuals are better able to justify dubious behavior when the behavior can be rationalized as benefitting other, less-fortunate individuals. Consequently, firms that offer equity compensation to rank and file employees may provide executives with a built-in justification to manage earnings (the Robin-Hood effect). Our results provide evidence that increases in rank and file employees’ equity-based compensation are associated with increases in earnings management. Cross-sectional tests are more consistent with economic incentives of rank and file employees accounting for our results rather than the Robin Hood effect influencing executives’ propensity to rationalize earnings management.

Keywords: Earnings management; rank and file employees; compensation; equity incentives; stock options; financial reporting quality

Suggested Citation

Holderness, Darin Kip and Huffman, Adrienna A. and Lewis-Western, Melissa Fay, Rank and File Equity Compensation and Earnings Management: Economic incentives and the Robin Hood Effect (May 9, 2018). AAA 2017 Management Accounting Section (MAS) Meeting, Available at SSRN: https://ssrn.com/abstract=2802714 or http://dx.doi.org/10.2139/ssrn.2802714

Darin Kip Holderness

West Virginia University ( email )

PO Box 6025
Morgantown, WV 26506
United States
3042937847 (Phone)
3042930635 (Fax)

Adrienna A. Huffman (Contact Author)

The Brattle Group ( email )

San Francisco, CA 9133
United States

Melissa Fay Lewis-Western

Brigham Young University - Marriott School of Business ( email )

Provo, UT 84602
United States
801-703-8426 (Phone)

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