Equity Incentives, Agency Conflict, and CEO Wealth-Pursuing Misreporting

Abstract

Conventional agency theory suggests that equity-based pay-for-performance sensitivity (i.e., delta) effectively mitigates agency conflict between incumbent shareholders and CEOs. However, rational choice theory in criminology suggests the opposite for the shareholder-CEO conflict that manifests as misreporting motivated by a CEO’s intention to pursue equity wealth (henceforth, wealth-pursuing misreporting). Does delta curb or aggravate such shareholder-CEO conflict? This question is difficult to address because a CEO’s misreporting intention is difficult to measure. To tackle this empirical challenge, we identify wealth-pursuing misreporting from the unstructured textual data in SEC Accounting and Auditing Enforcement Releases (AAERs). Consistent with rational choice theory, we find that the propensity for wealth-pursuing misreporting is strongly and positively associated with delta. Our findings have broad implications for using delta as a corporate governance tool to mitigate the shareholder-CEO conflict regarding financial reporting.

Keywords: CEO portfolio delta; Wealth-pursuing misreporting; Shareholder-CEO conflict; Shareholder-CEO confluence; AAER

JEL Classification: G34, J33, M41, M43