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

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: July 2019

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 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

Holderness, Darin Kip and Huffman, Adrienna A. and Lewis-Western, Melissa Fay, Rank and File Equity Compensation and Earnings Management: Evidence from Stock Options (July 2019). Forthcoming, Journal of Business Finance and Accounting, Available at SSRN: https://ssrn.com/abstract=3433869

Darin Kip Holderness

West Virginia University ( email )

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

Adrienna A. Huffman

The Brattle Group ( email )

San Francisco, CA 9133
United States

Melissa Fay Lewis-Western (Contact Author)

Brigham Young University - Marriott School of Business ( email )

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

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