Call Options and Accruals Quality

Jennifer Francis (), Per Olsson and Katherine Schipper
Additional contact information
Jennifer Francis: Fuqua School of Business, Duke University, Postal: Durham, NC 27708, USA
Per Olsson: Fuqua School of Business, Duke University
Katherine Schipper: Financial Accounting Standards Board

No 34, SIFR Research Report Series from Institute for Financial Research

Abstract: We analyze the link between financial reporting choices that affect accruals quality and firms' use of call options. We argue that call options used in compensation arrangements (employee stock options or ESOs) create countervailing incentives for managers to affect accruals quality. On the one hand, poorer accruals quality is associated with greater returns volatility (which leads to an increase in ESO value); on the other hand, better accruals quality is associated with a lower cost of capital (and, therefore, higher share price, which leads to an increase in ESO value). We confirm both effects on accruals quality, and we show that the net effect is for ESOs to worsen accruals quality. We provide additional evidence on this main result by showing that in two settings where the returns volatility incentive to worsen accruals quality is muted or absent (cases where managers hold employer shares and cases where the firm uses call options for financing purposes, such as preferred stock and convertible debt), the overall incentive is for managers to increase accruals quality.

Keywords: Options; Information Quality; Compensation (search for similar items in EconPapers)
JEL-codes: G30 M40 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2005-02-15
New Economics Papers: this item is included in nep-cfn and nep-fin
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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