Does Equity-based Compensation Cause Firms to Manage Earnings Per Share?

68 Pages Posted: 29 Nov 2017 Last revised: 3 Dec 2019

See all articles by Xing Gao

Xing Gao

University of Illinois at Urbana-Champaign

Mathias Kronlund

University of Illinois at Urbana-Champaign

Date Written: December 1, 2019

Abstract

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

Gao, Xing and Kronlund, Mathias, Does Equity-based Compensation Cause Firms to Manage Earnings Per Share? (December 1, 2019). Available at SSRN: https://ssrn.com/abstract=3073822 or http://dx.doi.org/10.2139/ssrn.3073822

Xing Gao

University of Illinois at Urbana-Champaign ( email )

601 E John St
Champaign, IL 61820
United States

Mathias Kronlund (Contact Author)

University of Illinois at Urbana-Champaign ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

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