Incentives and Opportunities to Manage Earnings Around Option Grants

36 Pages Posted: 23 Apr 2008

See all articles by Terry A. Baker

Terry A. Baker

Wake Forest University

Denton Collins

Texas Tech University - Rawls College of Business

Austin L. Reitenga

University of Alabama

Date Written: April 2008

Abstract

This study examines discretionary accruals imbedded in quarterly earnings announcements that precede executive stock option grants. Prior research indicates that managers attempt to increase the value of their option pay (by depressing the option's exercise price) through a variety of strategies including timing voluntary disclosures, influencing option grant dates, or managing accruals. This study extends the research by jointly examining managerial incentives and opportunities to pursue an accruals-based strategy. We find evidence that discretionary accruals are lower when option pay is high and when concurrent firm performance is poor (incentive factors), but only when firms issue grants following earnings announcements relatively infrequently (opportunity factor). For firms that follow a predictable grant schedule, managers behave as if they believe that investors will discount earnings-based signals preceding the grant. Our results suggest that the decision to pursue an option-related strategy is influenced by economic tradeoffs. From a policy perspective, our results have relevance for the ongoing debate over option compensation practices, appropriate disclosure to investors, and the quality of corporate earnings.

Keywords: Executive stock options, management incentives, earnings management, abnormal accruals, accruals reversals

JEL Classification: J33, M41, M43

Suggested Citation

Baker, Terry A. and Collins, Denton and Reitenga, Austin L., Incentives and Opportunities to Manage Earnings Around Option Grants (April 2008). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1124088

Terry A. Baker (Contact Author)

Wake Forest University ( email )

2601 Wake Forest Road
Calloway School of Business & Accountancy
Winston-Salem, NC 27109
United States
336-758-4323 (Phone)
336-758-6133 (Fax)

Denton Collins

Texas Tech University - Rawls College of Business ( email )

School of Accounting
Lubbock, TX 79409
United States

Austin L. Reitenga

University of Alabama ( email )

Culverhouse College of Commerce
Box 870223
Tuscaloosa, AL 78249
United States
205-348-5780 (Phone)

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