How Rank and File Equity Compensation Affects Earnings Management

Equity compensation is a beneficial tool when it motivates employees to engage more intensely in performance-enhancing activities. One negative consequence of equity compensation, however, is that it provides incentives to manage earnings (i.e., to strategically present financial reports or structure transactions in order mislead financial statement users about financial performance). Earnings management may sacrifice long-term firm value for short-term financial results, and prior research provides evidence that earnings management is more prevalent when executives have greater levels of equity compensation (e.g., Armstrong, Larcker, Ormazabal, & Taylor 2013).

Our forthcoming study in the Journal of Business Finance & Accounting extends prior … Read more