Target Ownership Plan and Earnings Management

Abstract

We examine the determinants of target ownership plans and their association with earnings management. We find that firms adopt target ownership plans not only in response to poor performance as documented by prior research, but also as a means to mitigate moral hazard concerns and in response to peer pressure. Our analyses show that firms engage in less accruals and real earnings management for up to two years following plan adoption. Additionally, we find that the reduction in accruals management is concentrated in adoption firms that have met the target ownership requirements, and in high probability adoption firms whose adoption decisions are driven by performance, moral hazard, governance, capital market, and peer-firm concerns. Our findings support the argument that target ownership plans align CEOs’ incentives with shareholders’ in that these plans result in reduced management short-termism as evidenced by more truthful earnings reporting and less real earnings management through production cost manipulation and discretionary expenditures.

Keywords: Target Ownership Plans, accruals management, real earnings management

JEL Classification: M41