Performance‐vested Stock Options and Earnings Management *

Performance‐vested Stock Options and Earnings Management * Abstract: This paper investigates the effects of performance‐vested stock options (PVSOs) on the propensity of managers to engage in earnings management. Using observations from the 240 largest non‐financial firms in the UK, I show that managers are more likely to engage in earnings management when they hold a larger proportion of their compensation in PVSOs. When categorizing PVSOs on the basis of their distance from the end of performance periods, the results show that managerial incentives to manage earnings mainly stem from PVSOs that are granted in prior years but within a performance evaluation period (i.e., PVSOs before vesting). Moreover, vesting targets influence the relationship between earnings management and PVSO compensation. The findings are consistent with the earnings smoothing hypothesis: confronted with more ambitious vesting targets, managers who are heavily loaded with PVSOs before vesting will report higher performance by generating greater accounting accruals, whereas in years with good performance, these managers will have incentives to reduce current reported performance by managing earnings downward so they can increase earnings as needed in the future. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Business Finance & Accounting Wiley

Performance‐vested Stock Options and Earnings Management *

Journal of Business Finance & Accounting, Volume 35 (9‐10) – Nov 1, 2008

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Publisher
Wiley
Copyright
© 2008 The Author Journal compilation © 2008 Blackwell Publishing Ltd
ISSN
0306-686X
eISSN
1468-5957
D.O.I.
10.1111/j.1468-5957.2008.02104.x
Publisher site
See Article on Publisher Site

Abstract

Abstract: This paper investigates the effects of performance‐vested stock options (PVSOs) on the propensity of managers to engage in earnings management. Using observations from the 240 largest non‐financial firms in the UK, I show that managers are more likely to engage in earnings management when they hold a larger proportion of their compensation in PVSOs. When categorizing PVSOs on the basis of their distance from the end of performance periods, the results show that managerial incentives to manage earnings mainly stem from PVSOs that are granted in prior years but within a performance evaluation period (i.e., PVSOs before vesting). Moreover, vesting targets influence the relationship between earnings management and PVSO compensation. The findings are consistent with the earnings smoothing hypothesis: confronted with more ambitious vesting targets, managers who are heavily loaded with PVSOs before vesting will report higher performance by generating greater accounting accruals, whereas in years with good performance, these managers will have incentives to reduce current reported performance by managing earnings downward so they can increase earnings as needed in the future.

Journal

Journal of Business Finance & AccountingWiley

Published: Nov 1, 2008

References

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