Reporting accountant appointments and accounting restatements: Evidence from UK private companies

In recent years, regulators have exempted an increasing number of companies from the requirement to appoint auditors, yet little is known about the role of the accounting profession in preparing and validating the financial statements of unaudited companies. In this paper, we examine empirically the factors associated with the appointment of reporting accountants. We then provide novel evidence on whether unaudited UK small private companies are less likely to restate their annual accounts when they have been prepared by an external accountancy firm (i.e., a reporting accountant). Based on a cross sectional analysis of a large sample of small private unaudited UK companies, we find that, in accordance with the ‘confirmation hypothesis’, larger companies that voluntarily disclose more financial information are more likely to appoint a reporting accountant. We also find that the accounts of companies with a reporting accountant are significantly less likely to be restated than those without. This result is more pronounced for companies disclosing more financial information and for those employing a larger accounting firm. Given the dwindling number of private companies opting for audits, our findings contribute to debates on the role of the accounting profession in enhancing private company financial reporting quality.     

CEO compensation, option incentives, and information disclosure

This paper examines the impact of information disclosure on the valuation of CEO options and the incentives created by those options. Prior executive compensation research in the US has made assumptions about key input variables that can affect the calculation of option values and financial incentives. Accordingly, biases may have ensued due to incomplete information disclosure about noncurrent option grants. Using new data on a sample of UK CEOs, we value executive option holdings and incentives for the first time and estimate the levels of distortion created by the less than complete US-style disclosure requirements. We also investigate the levels of distortion in the UK for the minority of companies that choose to reveal only partial information. Our results suggest that there have to date been few economic biases arising from less than complete information disclosure. Furthermore, we demonstrate that researchers using US data, who made reasonable assumptions about the inputs of noncurrent option grants, are unlikely to have made significant errors when calculating CEO financial incentives or option wealth. However, the recent downturn in the US stock market could result in the same assumptions, producing exaggerated incentive estimates in the future.     

Stock price crash risk and CEO power: Firm-level analysis

This study examines the impact of stock price crash risk on future CEO power. Using a large panel sample with 17,816 firm-year observations, we posit and find a significant negative impact of stock price crash risk on CEO power, suggesting that CEO power becomes smaller after stock price crashes. We also find that our results are stronger for firms with female CEOs and are largely driven by firms with shorter-tenure CEOs. In addition, we find that the significant negative impact of stock price crash risk on CEO power is diminished for firms with strong corporate governance. Our study responds to the call in Habib, Hasan, and Jiang (2018) by providing more empirical evidence on the consequences of stock price crash risk.     

Terrorist attacks and CEO compensation: UK evidence

This paper shows that both CEO compensation and rank-and-file employee compensation rise after terrorist attacks by employing a sample of 2558 firms in the UK from 1999 to 2018. The structure of CEO compensation growth differs in accordance with different cutoffs. Further analyses show that media coverage and CEO bargaining power accentuate the effect of terrorist attacks on CEO compensation and rank-and-file employee compensation, and the impact of media is mainly based on the information dissemination function. Our results remain valid after taking into account various robustness tests and endogeneity concerns.     

CEO incentive compensation and stock price momentum

We document strong evidence that CEO incentive compensation can predict the significance of stock price momentum through discretionary accrual and real activities manipulation. The profit of momentum strategy increases with CEO pay-for-performance incentive, but decreases with CEO risk-taking incentive. It also evaluates the effects of information uncertainty on such relationship. The evidence is more significant for firms with older and longer tenured CEOs and firms with more informed traders. The relationship between the profit of momentum strategy and CEO pay-for-performance incentive is stronger among CEOs without the risk-taking incentive. Our results are robust for different sub-samples based on before and after Reg FD and Sarbanes–Oxley Act, even after controlling for the potential endogeneity. Further, our findings are consistent with the information diffusion explanation of momentum and the agency theory that incentivised CEOs tend to manipulate information by smoothing good news, concealing mildly bad news and accelerating the disclosure of extremely bad news.     

Accounting fundamentals and CEO bonus compensation

Research indicates that there is a positive association between accounting earnings and chief executive officer (CEO) cash compensation; however, evidence also suggests that this positive association ceases to exist when earnings performance is poor or declining. This latter result has led some critics of corporate compensation policies to conclude that CEOs are not penalized for poor or declining firm performance. The purpose of this study is to further illuminate the pay-performance debate by expanding the traditional executive bonus compensation model to include a set of accounting fundamentals that prior research indicates are related to both current and future firm performance. Our results indicate that there is a highly significant relationship between accounting fundamentals and the level of and change in CEO bonus compensation. Moreover, we find a highly significant relationship between accounting fundamentals and both bonus omissions and bonus reductions. When earnings are negative or declining, we find that the above relationships remain intact. In contrast, when earnings are negative or declining, we find that the relationship between aggregate earnings and bonus compensation is weak or insignificant in most of our analyses. Taken together, our results suggest that the apparently weak relationship between accounting earnings and CEO bonus compensation (particularly when earnings are negative or declining) is partly due to the fact that the bonus compensation model excludes accounting fundamentals which are strongly associated with bonus compensation. Thus, we conclude that (i) bonus compensation is more closely tied to firm performance than critics sometimes claim and (ii) bonus compensation awarded to CEOs when earnings performance is poor is at least partially explained by the presence of favorable accounting fundamentals.     

Is CEO certification of earnings numbers value-relevant?

On June 27, 2002, the Securities and Exchange Commission of the United States ordered the CEOs and CFOs of 688 large firms to certify the earnings numbers of their companies by 5:30PM EST, Aug 14, 2002. This paper uses this natural experiment to find that certification was not only a non-event for the certifiers around their certification date, but it was also a non-event for the non-certifiers around Aug 15, 2002. Further tests make us conclude that CEO certification of earnings numbers is not value-relevant.     

Growth through rigidity: An explanation for the rise in CEO pay

The dramatic rise in CEO compensation during the 1990s and early 2000s is a longstanding puzzle. In this paper, we show that much of the rise can be explained by a tendency of firms to grant the same number of options each year. Number-rigidity implies that the grant-date value of option awards will grow with firm equity returns, which were very high on average during the tech boom. Further, other forms of CEO compensation did not adjust to offset the dramatic growth in the value of option pay. Number-rigidity in options can also explain the increased dispersion in pay, the difference in growth between the US and other countries, and the increased correlation between pay and firm-specific equity returns. We present evidence that number-rigidity arose from a lack of sophistication about option valuation that is akin to money illusion. We show that regulatory changes requiring transparent expensing of the grant-date value of options led to a decline in number-rigidity and helps explain why executive pay increased less with equity returns during the housing boom in the mid-2000s.     

Governance structure and the weighting of performance measures in CEO compensation

We empirically examine how governance structure affects the design of executive compensation contracts and in particular, the implicit weights of firm performance measures in CEO’s compensation. We find that compensation contracts in firms with higher takeover protection and where the CEO has more influence on governance decisions put more weight on accounting-based measures of performance (return on assets) compared to stock-based performance measures (market returns). In additional tests, we further find that CEO compensation in these firms has lower variance and a higher proportion of cash (versus stock-based) compensation. We further find that CEOs’ incentives (measured as changes in CEO annual wealth which includes expected changes in the value of the CEO’s equity holdings in addition to yearly compensation) do not vary across governance structures. These findings are consistent with CEOs in firms with high takeover protection and where they have more influence on governance negotiating different contracts.

Rank and file equity compensation and earnings management: Evidence from stock options

The widespread use of rank and file equity‐based compensation suggests that executives believe that rank and file employees can affect firm outcomes, and some research supports this view. If equity‐based incentives influence rank and file employees’ productive efforts, they might also influence their earnings management decisions. We find that increases in rank and file employees’ option‐based compensation—our proxy for equity‐based compensation—are associated with increases in earnings management and that this relation is attributable to real activities (as opposed to accrual) earnings management. Cross‐sectional tests indicate that the relation is stronger when rank and file option compensation is likely to generate greater performance incentives and attenuated in the presence of more intense monitoring. Finally, we explore the role of cash constraints and overvaluation as potential alternative explanations for this relation and find that neither accounts for our results.     

Media coverage,board structure and CEO compensation: Evidence from Taiwan

This paper investigates the relationship between CEO cash compensation and media coverage of firms, analyst forecasts and board structure using data from the Taiwan Stock Exchange. We find that, other things being equal, CEO cash compensation is much higher for firms with greater media coverage, firms with more positive news, firms with more analyst forecasts, and firms with larger institutional holdings. There is little evidence that board size and board independence affect CEO cash compensation, and CEO duality is negatively associated with CEO cash compensation     

Non-compensation-related consultant service and CEO compensation

This study examines how consultants’ non-compensation-related consulting service (NCS) affects the contractual usefulness of accounting and stock information in executive compensation, as reflected in pay-performance sensitivity. The hypothesis is based on anecdotal evidence suggesting that consultants’ provision of NCS is likely to adversely affect the quality of CEO compensation plans. We investigate whether the consultants providing NCS are involved in potential conflicts of interest. The results show that CEO pay is higher in companies where consultants provide NCS and have a higher NCS fee ratio. The pay-performance sensitivity in CEO compensation decreases when consultants engage in NCS. The overall results are consistent with NCS representing a conflict of interest and compromising the quality of compensation committees.     

Changes in CEO compensation structure and the impact on firm performance following CEO turnover

We document changes in compensation structure following CEO turnover and relate them to future performance. Compared to outgoing CEOs, incoming CEOs derive a significantly greater percentage of their compensation from option grants and new stock grants. The voluntary turnover sample shows similar changes in compensation structure while the forced turnover sample results suggest that new stock grants drive the significant increase in incentive compensation following turnover. Post-turnover performance is positively associated with new stock grants as a percentage of total compensation in the full sample and when analyzing forced and voluntary turnovers separately. We find limited evidence that future operating income is positively associated with option grants following forced turnover. Post-turnover improvement in operating income is positively associated with an increase in new stock grants for the incoming relative to the outgoing CEO.

The impact of bank merger growth on CEO compensation

We examine the impact of bank mergers on chief executive officer (CEO) compensation during the period 1992–2014, a period characterised by significant banking consolidation. We show that CEO compensation is positively related to both merger growth and non‐merger internal growth, with the former relationship being higher in magnitude. While CEO pay–risk sensitivity is not significantly related to merger growth, CEO pay–performance sensitivity is negatively and significantly related to merger growth. Collectively, our results suggest that, through bank mergers, CEOs can earn higher compensation and decouple personal wealth from bank performance. Furthermore, we document a more severe agency problem in CEO compensation as a consequence of bank mergers relative to mergers in industrial firms. Finally, we find that the post‐financial crisis regulatory reform of executive compensation in banks has limited effectiveness in curbing the merger–pay links.     

The dynamics of CEO equity vs. inside debt and firm performance

This paper provides new evidence on the comparative dynamic effects of CEO inside debt and equity compensation on firm performance as measured by Tobin’s Q. In contrast to the extant literature, we find significant empirical evidence supporting the classic Jensen and Meckling (1976) premise that managers should receive debt vs. equity compensation in proportion to the capital structure of the firm. We also provide new evidence showing that the effects of the CEO compensation structure on firm performance are dependent on the CEO’s time horizon, as measured by the expected period of employment to retirement. We show that the incremental benefits of equity compensation to performance increase with the CEO’s projected time to retirement. A similar, but insignificant relationship is observed for CEO inside debt compensation. Cash compensation is more beneficial to the firm when concentrated near the end of the CEO’s tenure.     

Share pledges,tone of earnings communication conferences,and market reaction: evidence from China

We investigate how share pledging affects firms’ disclosures and influences investors in Chinese stock market. The tone of firm disclosures when there are shares pledged by controlling shareholders is more positive than that of firms without them. Considering tone inflation motivation and ability simultaneously, we find share pledge risk has an inverted U‐shaped relation with tone. Investors react positively to tone in short‐run windows, and firms with controlling shareholders’ pledges have higher stock returns for earnings communication conferences. We identify an inverted U‐shaped link between margin distance of controlling shareholders and stock returns for earnings communication conferences.     

How employee stock options and executive equity ownership affect long-term IPO operating performance

To ascertain whether the form of managerial compensation affects a firm's long-term operating performance, we track IPOs for 5 years after the expiration of the stabilization period. New public companies perform better when managers receive a balanced combination of stock option grants and equity ownership. Firms with unbalanced compensation arrangements, large option grants and little equity ownership or vice versa do not perform as well. This empirical finding is consistent with a theoretical explanation based on managerial risk aversion and the alignment of managerial and owner incentives.     

Corporate governance or globalization: What determines CEO compensation in China?

This paper examines the relationship between corporate governance and CEO compensation in China. In contrast to results derived from U.S. data, we find little evidence that Chinese CEOs take advantage of weaker board structures or less demanding shareholders to extract higher compensation packages. Instead, our results lend support to the view that the increasingly global managerial labor market and compensation standards have a greater impact on CEO pay level. Our study suggests that CEOs in developing economies like China, in our case, benefit more from their degree of exposure to these changes than from corporate governance imperfections.     

The differential CEO dominance-compensation and corporate governance-compensation relations: Pre- and post-SOX

We examine the relationship between corporate governance (as measured by traditional corporate governance variables and a new measure of corporate governance, called CEO dominance) and executive compensation, pre- and post-SOX. We conceptualize CEO dominance as a measure of a CEO's power and define it as the difference between CEO pay and the next highest executive's pay divided by the CEO's pay. We argue that for traditional corporate governance variables, the inverse governance-compensation relation that exists pre-SOX will improve post-SOX. On the other hand, we expect a strong and positive CEO dominance-compensation relation to exist both pre- and post-SOX. Consistent with expectations, our results indicate that SOX has changed the relationship between CEO duality and compensation relation, but it has not changed the CEO dominance-compensation relation. This suggests that SOX regulatory reforms do not limit the ability of CEO power to obstruct traditional corporate governance mechanisms in extracting compensation-related rents.