Does Equity-based Compensation Cause Firms to Manage Earnings Per Share?
68 Pages Posted: 29 Nov 2017 Last revised: 3 Dec 2019
Date Written: December 1, 2019
Equity-based compensation causes increases in firms' share count and dilutes Earnings Per Share (EPS), which can provide firms with an incentive to raise EPS through earnings management or repurchases. This paper presents evidence of a causal link between equity-based pay and EPS management. We employ a regression discontinuity framework to compare firms that experience dilution from "just-in-the-money'' option exercises with firms whose options end up narrowly out-of-the-money. We show that firms engage in real- and accruals-based earnings management, but not repurchases, to boost EPS around these plausibly exogenous dilutive events. These effects exist only when earnings are positive and dilution therefore depresses EPS, and are stronger in firms where executive compensation is directly tied to EPS.
Keywords: executive compensation, earnings per share, equity incentives, option exercises, regression discontinuity, dilution, earnings management, share repurchases
JEL Classification: G30, G35, J33, M43
Suggested Citation: Suggested Citation