Equity Incentives and Earnings Management

57 Pages Posted: 26 Oct 2003 Last revised: 16 Apr 2013

See all articles by Qiang Cheng

Qiang Cheng

Singapore Management University

Terry Warfield

University of Wisconsin - Wisconsin School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: November 1, 2004

Abstract

This paper examines the link between managers' equity incentives - arising from stock-based compensation and stock ownership - and earnings management. We hypothesize that managers with high equity incentives are more likely to sell shares in the future and this motivates these managers to engage in earnings management to increase the value of the shares to be sold. Using stock-based compensation and stock ownership data over the 1993-2000 time period, we document that managers with high equity incentives sell more shares in subsequent periods. As expected, we find that managers with high equity incentives are more likely to report earnings that meet or just beat analysts' forecasts. We also find that managers with consistently high equity incentives are less likely to report large positive earnings surprises. This finding is consistent with the wealth of these managers being more sensitive to future stock performance, which leads to increased reserving of current earnings to avoid future earnings disappointments. Collectively, our results indicate that equity incentives lead to incentives for earnings management.

Keywords: Equity incentives, stock-based compensation, stock ownership, insider trading, earnings management, meeting or beating analysts' forecasts, abnormal accruals

JEL Classification: M41, M43, G29, J33

Suggested Citation

Cheng, Qiang and Warfield, Terry D., Equity Incentives and Earnings Management (November 1, 2004). Sauder School of Business Working Paper, Available at SSRN: https://ssrn.com/abstract=457840 or http://dx.doi.org/10.2139/ssrn.457840

Qiang Cheng

Singapore Management University ( email )

60 Stamford Road
Singapore, 178900
Singapore

Terry D. Warfield (Contact Author)

University of Wisconsin - Wisconsin School of Business ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

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