ch8.1bartol et al

ch8.1bartol et al - Academy of Management Journal 2008,...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
CEOS ON THE EDGE: EARNINGS MANIPULATION AND STOCK-BASED INCENTIVE MISALIGNMENT XIAOMENG ZHANG American University KATHRYN M. BARTOL KEN G. SMITH University of Maryland MICHAEL D. PFARRER University of Denver DMITRY M. KHANIN California State, Fullerton Synthesizing agency theory and prospect theory, we examined the effects of stock- based incentives on CEO earnings manipulation behaviors. In analyses of data com- piled from the public companies listed in Compustat’s Executive Compensation Data- base and a U.S. General Accounting Office restatements database, we found that CEOs were more likely to manipulate firm earnings when they had more out-of-the-money options and lower stock ownership. Firm performance and CEO tenure interacted with out-of-the-money options and ownership to influence CEO earnings manipulation behaviors. Our findings inform agency-based views by providing evidence that, under certain conditions, stock-based managerial incentives lead to incentive misalignment. Inappropriate behavior by management (e.g., earnings manipulation, fraudulent financial report- ing) has long been an important area of interest to scholars, regulators, investors, and the public at large. The recent high-profile scandals at Enron, Tyco, and WorldCom have drawn increased atten- tion to earnings manipulation activities (Levitt, 1999; Wu, 2002). These corporate failures highlight the fact that earnings management can be abused (Davidson, Jiraporn, Kim, & Nemec, 2004; Erickson, Earnings manipulation is intentional misapplica- tion of accounting rules and misreporting of finan- cial results that causes reported income to be larger or smaller than it would otherwise be (Davidson et al., 2004; Elitzur & Yaari, 1995; General Accounting Office [GAO], 2003). Prior evidence indicates that capital markets react negatively to earnings manip- ulation because it involves decisions that may lead to severe declines in a company’s stock price, the exposure of auditors to litigation risk and reputa- tional damage, turnover among top management within the company, prison sentences for top exec- utives, filings for bankruptcy, and loss of investor confidence (Pratt & Stice, 1994; Richardson, Tuna, & Wu, 2002; Weber, Little, Henry, & Lavelle, 2001; Wu, 2002). Although the accounting and financial disci- plines have a long history of examining earnings management and aggressive accounting practices (see Healy and Wahlen [1999] for a review), previ- ous research has predominantly focused on ante- cedents of earnings manipulation at an industry level, such as industry competition and regulation firm level, such as financial condition and struc- Committee of Sponsoring Organizations of the Treadway Commission, which investigated the key factors influencing firms subject to enforcement ac- tion for accounting fraud, concluded that the CEOs
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 05/29/2011 for the course MAN 5721 taught by Professor Collins during the Summer '10 term at Florida A&M.

Page1 / 19

ch8.1bartol et al - Academy of Management Journal 2008,...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online