Accounting Papers

Document Type

Journal Article

Date of this Version

8-2013

Publication Source

Journal of Financial Economics

Volume

109

Issue

2

Start Page

327

Last Page

350

DOI

10.1016/j.jfineco.2013.02.019

Abstract

Prior research argues that a manager whose wealth is more sensitive to changes in the firm׳s stock price has a greater incentive to misreport. However, if the manager is risk-averse and misreporting increases both equity values and equity risk, the sensitivity of the manager׳s wealth to changes in stock price (portfolio delta) will have two countervailing incentive effects: a positive “reward effect” and a negative “risk effect.” In contrast, the sensitivity of the manager׳s wealth to changes in risk (portfolio vega) will have an unambiguously positive incentive effect. We show that jointly considering the incentive effects of both portfolio delta and portfolio vega substantially alters inferences reported in prior literature. Using both regression and matching designs, and measuring misreporting using discretionary accruals, restatements, and enforcement actions, we find strong evidence of a positive relation between vega and misreporting and that the incentives provided by vega subsume those of delta. Collectively, our results suggest that equity portfolios provide managers with incentives to misreport when they make managers less averse to equity risk.

Copyright/Permission Statement

© 2013. This manuscript version is made available under the CC-BY-NC-ND 4.0 license http://creativecommons.org/licenses/by-nc-nd/4.0/

Keywords

equity incentives, executive compensation, misreporting, earnings management, restatements, SEC enforcement actions

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Date Posted: 27 November 2017

This document has been peer reviewed.