Stock Option Compensation and Managerial Discretion in the Insurance Industry: Are Reserves Manipulated to Enhance Profitability?

27 Pages Posted: 11 Dec 2004

See all articles by Mark J. Browne

Mark J. Browne

St. John's University - Peter J. Tobin College of Business

Yu-Luen Ma

Illinois State University - Katie Insurance School

Ping Wang

St. John's University - School of Risk Management, Insurance and Actuarial Science

Date Written: December 3, 2004

Abstract

Stock options create an incentive for managers of companies to maximize the value of their company's stock. Prior research has hypothesized that managers of insurers manipulate reserve levels to achieve organization goals, including minimization of taxes and income smoothing. The current study tests whether the awarding of stock options to insurance company executives is associated with the accuracy of reserve estimates. We test two competing hypotheses. The first hypothesis is that the granting of options to executives encourages under reserving. This would be the case if inflated earnings resulting from under reserving result in higher insurer stock valuations. The second hypothesis is that grants of options to executives result in more accurate reserving. Empirical support for this hypothesis would suggest the market valuations of insurers' stock take into consideration the perceived accuracy of financial disclosures and that valuations are higher for firms that report more accurate reserve estimates. Consequently, executives holding options will attempt to report reserve estimates as accurately as possible. Our empirical analyses support the hypothesis that insurers that award stock options estimate reserves more accurately than other insurers, other things equal.

Keywords: Stock options, executive compensation, reserves, insurance

JEL Classification: G22, G34, J33, M41

Suggested Citation

Browne, Mark J. and Ma, Yu-Luen and Wang, Ping, Stock Option Compensation and Managerial Discretion in the Insurance Industry: Are Reserves Manipulated to Enhance Profitability? (December 3, 2004). Available at SSRN: https://ssrn.com/abstract=629383 or http://dx.doi.org/10.2139/ssrn.629383

Mark J. Browne (Contact Author)

St. John's University - Peter J. Tobin College of Business ( email )

New York, NY
United States

Yu-Luen Ma

Illinois State University - Katie Insurance School ( email )

Normal, IL 61790
United States

Ping Wang

St. John's University - School of Risk Management, Insurance and Actuarial Science ( email )

United States

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