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Rank and file equity compensation and earnings management: Evidence from stock options

D. Kip Holderness, Adrienna Huffman and Melissa Lewis‐Western

Journal of Business Finance & Accounting, 2019, vol. 46, issue 9-10, 1201-1236

Abstract: The widespread use of rank and file equity‐based compensation suggests that executives believe that rank and file employees can affect firm outcomes, and some research supports this view. If equity‐based incentives influence rank and file employees’ productive efforts, they might also influence their earnings management decisions. We find that increases in rank and file employees’ option‐based compensation—our proxy for equity‐based compensation—are associated with increases in earnings management and that this relation is attributable to real activities (as opposed to accrual) earnings management. Cross‐sectional tests indicate that the relation is stronger when rank and file option compensation is likely to generate greater performance incentives and attenuated in the presence of more intense monitoring. Finally, we explore the role of cash constraints and overvaluation as potential alternative explanations for this relation and find that neither accounts for our results.

Date: 2019
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Journal of Business Finance & Accounting is currently edited by P. F. Pope, A. W. Stark and M. Walker

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