Earnings Management and Executive Compensation: A Case of Overdose of Option and Underdose of Salary?

48 Pages Posted: 22 Mar 2002  

Ronald E. Shrieves

University of Tennessee, Knoxville - Department of Finance

Pengjie Gao

University of Notre Dame - Mendoza College of Business

Date Written: July 29, 2002

Abstract

We present and test hypotheses about how the components of compensation influence earnings management behavior. Hypotheses are based, in part, on the observation that discretion over accounting accruals gives managers a potentially valuable timing option that will lead to strategies for maximizing their compensation. Our empirical analysis shows that earnings management intensity, as measured by the absolute value of discretionary current accruals scaled by asset size, is related to managerial compensation contract design. We find the amounts of stock options and bonuses, and the incentive intensity of stock options, are positively related to earnings management intensity, whereas salaries are negatively related. Results do not reliably support either positive or negative effects of long-term incentive plans or restricted stock compensation on earnings management intensity, aside from the incentive intensity effect of restricted stock. We show that magnitudes of the effects of some compensation variables on earnings management intensity are conditional on proximity of premanaged earnings to specified targets. The importance of our findings is the strong evidence they provide that compensation contract design does influence earnings management, and that the influences of the various compensation components appear to be largely predictable on a presumption that (at least some) managers behave opportunistically.

Keywords: executive compensation, earnings management

JEL Classification: G32, G34

Suggested Citation

Shrieves, Ronald E. and Gao, Pengjie, Earnings Management and Executive Compensation: A Case of Overdose of Option and Underdose of Salary? (July 29, 2002). EFA 2002 Berlin Meetings Presented Paper. Available at SSRN: https://ssrn.com/abstract=302843 or http://dx.doi.org/10.2139/ssrn.302843

Ronald E. Shrieves (Contact Author)

University of Tennessee, Knoxville - Department of Finance ( email )

Knoxville, TN 37996
United States

Pengjie Gao

University of Notre Dame - Mendoza College of Business ( email )

246 Mendoza College of Business
Notre Dame, IN 46556-5646
United States
(574) 631-8048 (Phone)

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