Earnings Smoothing,Executive Compensation,and Corporate Governance: Evidence From the Property–Liability Insurance Industry

Unlike studies that estimate managerial bias, we utilize a direct measure of managerial bias in the U.S. insurance industry to investigate the effects of executive compensation and corporate governance on firms’ earnings management behaviors. We find managers receiving larger bonuses and stock awards tend to make reserving decisions that serve to decrease firm earnings. Moreover, we examine the monitoring effect of corporate board structures in mitigating managers’ reserve manipulation practices. We find managers are more likely to manipulate reserves in the presence of particular board structures. Similar results are not found when we employ traditional estimated measures of managerial bias.     

CEO compensation and incentives: Evidence from M&A bonuses

We investigate CEO compensation for completing M&A deals. We find that CEOs who have more power to influence board decisions receive significantly larger bonuses. We also find a positive relation between bonus compensation and measures of effort, but not between bonus compensation and deal performance. CEOs with more power also tend to engage in larger deals relative to the size of their own firms, and the market responds more negatively to their acquisition announcements. Our evidence is consistent with the argument that managerial power is the primary driver of M&A bonuses.     

Managerial incentives,capital reallocation,and the business cycle

We argue that when managers have private information about the productivity of assets under their control and receive private benefits, substantial bonuses are required to induce less productive managers to declare that capital should be reallocated. The need to provide incentives for managers to relinquish control links executive compensation to capital reallocation and managerial turnover over the business cycle, rendering them procyclical if expected managerial compensation increases when more managers are hired. Moreover, capital is less productively deployed in downturns because agency costs make reallocation more costly. Empirically, we find that both CEO turnover and executive compensation are remarkably procyclical.     

The role of tax regulation and compensation contracts in the decision to voluntarily expense employee stock options

We show that firms with executive bonuses that qualify for deduction under Internal Revenue Code Section 162(m) were less likely to expense stock option compensation (SOC) in 2002. Additionally, the more likely it is that a qualified firm will incur re-contracting costs, the less likely it is that the firm will expense SOC. CEOs of qualified firms that also expense SOC receive smaller bonuses than CEOs of expensing firms that are not qualified under 162(m), and the lower 162(m) bonuses are not offset by higher SOC. Our results suggest that 162(m) tax incentives are an important determinant of the decision to expense SOC.     

Pay me now (and later): Pension benefit manipulation before plan freezes and executive retirement

Large US firms modify top executives’ compensation before pension-related events. Top executives receive one-time increases in pensionable earnings through higher annual bonuses one year before a plan freeze and one year before retirement. Firms also boost pension payouts by lowering plan discount rates when top executives are eligible to retire with lump-sum benefit distributions. Increases in executive pensions do not appear to be an attempt to improve managerial effort or retention and are more likely to occur at firms with poor corporate governance. These findings suggest that in some circumstances managers are able to extract rents through their pension plans.     

Effective Post‐Signing Market Check or Window Dressing? The Role of Go‐Shop Provisions in M&A Transactions

This paper examines the use of go‐shop provisions in M&A. We find that go‐shop deals tend to have higher deal premiums and receive more competing bids while the length of the go‐shop period does not affect deal premium and competition. Also, deals are less likely to be completed when a go‐shop provision is included and when the go‐shop length is longer. However, go‐shops have no effect on the completion of high premium deals. We also find that the presence of a go‐shop provision leads to a positive market reaction to deal announcements. Overall, our findings support the proposition that go‐shops reflect the efforts of target managers to fulfill the Revlon duties in the form of a post‐signing market check, which is consistent with stewardship theory.     

A Temporal Analysis of Earnings Surprises: Profits versus Losses

I show that median earnings surprise has shifted rightward from small negative (miss analyst estimates by a small amount) to zero (meet analyst estimates exactly) to small positive (beat analyst estimates by a small amount) during the 16 years, 1984 to 1999. I show that a rightward temporal shift in median surprise from negative to positive describes earnings, but neither profits nor losses. Median profit surprise shifts within the positive quadrant, from zero to one cent per share. Median loss surprise shifts within the negative quadrant from extreme negative (about -33 cents per share) to zero. I show that the median surprise for profits exceeds that for losses in every year. I document significant positive temporal trends in both meet and beat analyst estimates for both profits and losses, but I find a greater frequency of profits that either meet or beat analyst estimates in every year. I find a significant positive temporal trend in positive profits that are "a little bit of good news," and a significant negative temporal trend in managers who report losses that are an "extreme amount of bad news." My results are robust to the four internal validity threats I consider—namely temporal changes in: (1) analyst forecast accuracy, (2) the mix of earnings of one sign preceded by earnings of another sign four quarters ago, (3) the timeliness of the most recent analyst forecast, and (4) the I/B/E/S definition of actual earnings. I find that managers of growth firms are relatively more likely than managers of value firms to report good news profits. I show that when they do report positive profit surprises, managers of growth firms are more likely to report "a little bit of good news" in every year.     

CEO Compensation and Fair Value Accounting: Evidence from Purchase Price Allocation

This study investigates the impact of CEO compensation structure on post‐acquisition purchase price allocation, an accounting procedure that involves fair value estimation of various assets and liabilities. We find that CEOs whose compensation packages rely more on earnings‐based bonuses are more likely to overallocate the purchase price to goodwill, the largest asset recorded post‐acquisition. Because goodwill is not amortized, the overallocation likely increases post‐acquisition earnings and bonuses. We also find that, when the acquirer's CEO bonus plan includes performance measures that are not affected, or are less affected, by the overstatement of goodwill, such as cash flows, sales, or earnings growth, the overallocation to goodwill motivated by bonus plans diminishes.     

Bank Risk Taking at the Onset of the Current Banking Crisis

We analyze bank governance, share ownership, CEO compensation, and bank risk taking in the period leading to the current banking crisis. Using a sample of large U.S. bank holding companies (BHCs), we find that BHCs with greater managerial control, achieved through various corporate governance mechanisms, take less risk. BHCs that pay CEOs high base salaries also take less risk, while BHCs that grant CEOs more in stock options or that pay CEOs higher bonuses take more risk. The evidence is generally consistent with BHC managers exhibiting greater risk aversion than outside shareholders, but with several factors affecting managers’ risk‐taking incentives.     

Credit Ratings and Earnings Management around IPOs

This study examines the impact of having a credit rating on earnings management (EM) through accruals and real activities manipulation by initial public offering (IPO) firms. We find that firms going public with a credit rating are less likely to engage in income‐enhancing accrual‐based and real EM in the offering year. The monitoring by a credit rating agency (CRA) and the reduced information asymmetry due to the provision of a credit rating disincentivise rated issuers from managing earnings. We also suggest that the participation of a reputable auditing firm is crucial for CRAs to effectively restrain EM. Moreover, we document that for unrated issuers, at‐issue income‐increasing EM is not linked to future earnings and is negatively related to post‐issue long‐run stock performance. However, for rated issuers, at‐issue income‐increasing EM is positively associated with subsequent accounting performance and is unrelated to long‐run stock performance following the offering. The evidence indicates that managers in unrated firms generally manipulate earnings to mislead investors, while managers in rated firms tend to exercise their accounting and operating discretion for informative purposes.     

Stable Shareholdings,the Decision Horizon Problem and Earnings Smoothing

Prior studies argue that stable shareholders do not encourage firm managers to manage their earnings to achieve short‐term earnings goals. They also state that firm managers with stable shareholders have an incentive to report smooth earnings to maintain long‐term relationships with such shareholders. We focus on cross‐shareholdings and stable shareholdings owned by financial institutions as stable shareholdings in Japan, and investigate the effect of these ownership structures on earnings management patterns. Specifically, we hypothesize that stable shareholdings are positively associated with the informational components of earnings smoothing. Consistent with our hypothesis, we first find that as stable shareholdings increase, managers are more likely to conduct earnings smoothing that provides useful information to stable shareholders. Further, our additional analysis shows that stable shareholdings reduce incentives for managers to cut discretionary expenditures to meet short‐term earnings benchmarks, implying that stable shareholdings could reduce the possibility of a myopic problem. These results suggest that managers with stable shareholdings tend to report smoother and less volatile earnings, and do not tend to pursue earnings management to attain short‐term earnings targets.     

Do Sales of Foreign Exchange Reserves Lead to Currency Appreciation?

We employ novel time‐stamped reserve sales data, provided by the Czech National Bank (CNB), to carry out a time‐series analysis of the exchange rate implications of Czech reserve sales aimed at mitigating valuation losses on Euro‐denominated assets. The sales were explicitly not intended to influence the value of the koruna relative to the euro. The period under study includes a well‐defined regime change in the CNB's approach to reserves sales, allowing us to address whether the manner in which the sales are carried out matters for their influence on the relative value of the domestic currency. We find little evidence that reserve sales influence the exchange rate when sales are carried out on a discretionary and relatively infrequent basis. However, when the sales are carried out daily, we find a statistically and economically significant appreciation of the domestic currency follows.     

Do Insiders Manipulate Earnings When They Sell Their Shares in an Initial Public Offering?

In this article we examine whether insider share selling in an initial public offering (IPO) influences R&D expenditures. Insiders (managers and venture capitalists) who sell their pre‐offering shareholdings might try to increase the IPO offer price (1) by overinvesting in R&D to signal the firm's prospects (the signaling hypothesis) or (2) by underinvesting in R&D to increase current reported earnings (the earnings fixation hypothesis). We find that, for a sample of 243 IPOs from 1986 to 1990, change in R&D spending in the year of the IPO is negatively related to managerial selling. Because reductions in R&D spending increase current earnings at the expense of future earnings, our evidence suggests that managers believe that investors place more emphasis on current earnings and less emphasis on R&D and therefore spend less on R&D. We also document a positive association between discretionary current accruals in the offering year and managerial selling, suggesting that selling managers manipulate accruals as well.     

Target ratcheting and effort reduction

In this paper, we examine how retail store managers reduce their sales activity in response to target ratcheting. We find that managers with favorable sales performance in the first three quarters reduce their sales activity in the final quarter. We also document that managers who engage in sales reducing activities enhance their likelihood of meeting their next-year sales target, which is based on their current sales. That is, managers who reduce their sales activity in the final quarter are more likely to beat their next-year sales targets than managers who refrain from reducing their final-quarter sales.     

ALIGNMENT EXPOSED: HOW CEOS ARE PAID, AND WHAT THEIR SHAREHOLDERS GET FOR IT

This article begins by arguing that, for many companies, there is a significant "disconnect" between how managers are paid and what is actually achieved for shareholders. This paper answers two questions of prime importance to investors: Is there a way to know beforehand whether managers' incentives are well aligned with those of its shareholders? And does such alignment actually make a difference in the returns one is likely to see?
In answering the first question, the author argues that cash bonuses and performance-based equity grants (i.e., grants based on managers' meeting accounting-based operating targets) are likely to provide stronger, more cost-effective incentives than grants of stock or options because the former are generally based on measures over which managers have significantly more control than the stock price. Using this insight, the author develops a method for evaluating compensation structures based on the variability of compensation, the number and type of compensation metrics purportedly driving that variability (including the award of performance shares or options), the stability of those metrics over time, and the apparent level of discretion in the use of those metrics to either fund or distribute bonuses (including equity). All these elements are disclosed to varying degrees in the proxy statements or annual reports of companies.
Using his compensation scores for 140 companies and their return history over the last eight years, the author concludes that "high alignment" companies outperform their "low alignment" peers by more than 5% per year in total shareholder returns. Furthermore, increases in alignment scores by individual companies over time tend to lead to higher total shareholder returns, and degradation of scores lead to lower returns. In short, observable improvements in compensation structure appear to pay off in the form of significant abnormal returns.     

The gender gap in bank credit access

We use a sample of over 80,000 Spanish companies started by a sole entrepreneur between 2004 and 2014, and distinguish between male and female entrepreneurs demand for credit, credit approval ratio, and credit performance. We find that female entrepreneurs who start a business are less likely to ask for a loan. Of the female entrepreneurs requesting a credit, the probability of obtaining one in the founding year is significantly lower than their male peers in the same industry. This lower credit access disappears over the subsequent years, once the company has a track record of profits and losses. We also observe that women-led companies that receive a loan in the founding year are less likely to default as compared to men-led companies. This superior performance disappears for subsequent years, coinciding with the disappearance of the lower credit access. Taking all these results together, we rule out both taste-based discrimination and statistical discrimination in the credit industry, and point to the possible presence of double standards which might be a consequence of implicit (unconscious) discrimination.     

CEO Bonus Compensation and Bank Default Risk: Evidence from the U.S. and Europe

We investigate the link between the incentive mechanisms embedded in CEO cash bonuses and the riskiness of banks. For a sample of U.S. and European banks, we employ the Merton distance to default model to show that increases in CEO cash bonuses lower the default risk of a bank. However, we find no evidence of cash bonuses exerting a risk‐reducing effect when banks are financially distressed or when banks operate under weak bank regulatory regimes. Our results link bonus compensation in banking to financial stability and caution that attempts to regulate bonus pay need to tailor CEO incentives to the riskiness of banks and to regulatory regimes.     

Managers: Their Effects on Accruals and Firm Policies

This paper investigates whether top executives have significant individual‐specific effects on accruals that cannot be explained by firm characteristics. Exploiting individual executive and firm data from a period of 37 years, we find that individual executives play a significant role in determining firms’ accruals. We examine whether executives’ effects on accruals are related to their personal styles on firm policies, investment, financing and operating decisions. Our results show that individual executives’ effects on accruals are more correlated with their operating decisions than investment and financing decisions. We next investigate whether managers themselves also have a personal style for directly affecting accruals. We compare effects exerted by CEOs to CFOs. We find CEOs are more likely to affect accruals through firm policy decisions and CFOs are more likely to affect accruals through accounting decisions. CFOs tend to report more ‘solid’ earnings than CEOs, i.e., CFOs are more likely to push accruals to zero.     

Acquisitions,Overconfident Managers and Self‐attribution Bias

We examine whether acquisitions by overconfident managers generate superior abnormal returns and whether managerial overconfidence stems from self‐attribution. Self‐attribution bias suggests that overconfidence plays a greater role in higher order acquisition deals predicting lower wealth effects for higher order acquisition deals. Using two alternative measures of overconfidence (1) high order acquisition deals and (2) insider dealings we find evidence supporting the view that average stock returns are related to managerial overconfidence. Overconfident bidders realise lower announcement returns than rational bidders and exhibit poor long‐term performance. Second, we find that managerial overconfidence stems from self‐attribution bias. Specifically, we find that high‐order acquisitions (five or more deals within a three‐year period) are associated with lower wealth effects than low‐order acquisitions (first deals). That is, managers tend to credit the initial success to their own ability and therefore become overconfident and engage in more deals. In our analysis we control for endogeneity of the decision to engage in high‐order acquisitions and find evidence that does not support the self‐selection of excessive acquisitive firms. Our analysis is robust to the influence of merger waves, industry shocks, and macroeconomic conditions.     

Noncompliance with non‐accounting securities regulations and GAAP violations

Using enforcement actions by the Securities and Exchange Commission (SEC) as a proxy for noncompliance with securities regulations, we examine whether a firm's compliance with non‐accounting laws and regulations is associated with GAAP violations. We find that firms that violate securities regulations related to non‐accounting issues are more likely to report accounting restatements than control firms that comply with securities regulations. We also find that the difference between the two groups is significant only for the periods subsequent to the start of the noncompliance period but not for periods prior to this date. Our results highlight the interrelation between the accounting and compliance systems, and suggest that managers who are non‐compliant with non‐accounting regulations are also more likely to be non‐compliant with accounting rules.