Rank and File Equity Compensation and Earnings Management: Evidence from Stock Options
Forthcoming, Journal of Business Finance and Accounting
62 Pages Posted: 12 Aug 2019
Date Written: July 2019
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 their earnings management decisions. We find that increases in rank and file employees’ option-based compensation — our proxy for equity-based compensation — are associated with increases in earnings management and that this relation is attributable to real activities (as opposed to accrual) earnings management. Cross-sectional tests indicate that the relation is stronger when rank and file option compensation is likely to generate greater performance incentives and attenuated in the presence of more intense monitoring. Finally, we explore the role of cash constraints and overvaluation as potential alternative explanations for this relation and find that neither accounts for our results.
Keywords: earnings management, equity compensation, rank and file employees, accrual-based earnings management, real earnings management, equity incentives,stock options, financial reporting quality,earnings quality, fraud
JEL Classification: M41, M12
Suggested Citation: Suggested Citation