The relation between equity incentives and misreporting: The role of risk-taking incentives 吴圆圆 16720847

Basic Information Author: Christopher S. Armstrong, David F. Larcker, Gaizka Ormazabal, Daniel J. Taylor Publisher: Journal of Financial Economics Publish date: 1 March 2013 Research Questions: Examine the relation about the incentive effects of a manager’s equity on the decision to misreport.

Research Importance With rare exception, prior work focuses on how managers benefit from an increase in stock price without considering the economic consequences of any corresponding changes in firm risk. This is an important omission because there are substantial monetary and nonmonetary risks associated with the decision to misreport. This observation explain why prior empirical research finds mixed evidence on the relation between portfolio delta and misreporting.

Sample and variable measurement Sample construction Our tests require data on executive compensation and equity holdings, firm performance, and proxies for misreporting. We construct our sample by collecting data on executive compensation and equity holdings from Execucomp, stock returns, and financial statement information from the Center for Research in Security Prices (CRSP)/Compustat Industrial file, accounting restatements from Audit Analytics, and SEC Accounting and Auditing Enforcement Releases from the Center for Financial Reporting and Management. Our sample is constructed as the intersection of these four data sets, and consists of 20,445 firm-years (2,446 firms) over the period 1992– 2009.

Sample and variable measurement -Variable measurement Measures of misreporting We examine the relation between equity incentives and misreporting using three measures of misreporting that are common in the literature: the absolute value of discretionary accruals, accounting restatements, and AAERs By using three measures of misreporting, we aim to show that our inferences apply to misreporting in general and are not specific to any one measure of misreporting.

Sample and variable measurement -Variable measurement Measures of incentives Variable Design In our primary tests, we measure incentives using total cash compensation, the sensitivity of the manager’s wealth to changes in equity price (portfolio delta), and the sensitivity of the manager’s wealth to changes in equity risk (portfolio vega). Consistent with prior work, we focus on the equity incentives of the top management team.

Research design Our research design choices closely follow prior research. Specifically, we examine the relation between equity incentives and misreporting using both regression tests and matched-sample tests. regression tests matched-sample tests we divide the sample into treatment firms (firm i) and matched-sample firms (firm j) by numerically solving for the set of matches that minimizes the sum of the pairwise distance measure: we replicate a representative regression used in prior research examining the relation between portfolio delta and a specific misreporting proxy. We then examine whether inferences are sensitive to controlling for risk- taking incentives, and whether within- firm variation in portfolio delta and portfolio vega explains within-firm variation in misreporting by including firm fixed effects in the specification. We estimate a series of regressions that take the form: We then assess the success of the resulting matched- pairs by testing for covariate balance between treatment firms and matched-sample firms. Misreporting is one of three measures of misreport- ing (Discretion, Restatement, or AAER), Incentives is the vector of incentive variables (CashComp, Delta, and Vega), and Controls is a vector of control variables. For a successful match, where the treatment and control samples are similar along all measured dimensions except for observed risk-taking incentives (Vega), any difference in the level of misreporting between the two samples is attributable to the difference in risk-taking incentives

Research conclusions 1. This literature argues that a manager whose wealth is more sensitive to changes in stock price has a greater incentive to misreport. 2. When managers are risk-averse, it is important to jointly consider both portfolio delta and portfolio vega when assessing the relation between equity incentives and misreporting. 3. We find inferences in studies reporting either a positive relation or no relation between portfolio delta and misreporting are not robust to controlling for vega. 4. Variation in risk-taking incentives explains not only variation in misreporting across firms, but also time- series variation in misreporting within a firm. 5.The results suggest that equity portfolios provide managers with incentives to misreport not because they tie the manager’s wealth to equity value, but because they tie the manager’s wealth to equity risk.

Inadequancy The capital asset pricing model is flawed Our results potentially reconcile the conflicting evidence reported in prior studies that focus exclusively on portfolio delta. Lack of external validity Stock market is not completely effective in our country . Therefore, the modle used in this artical can not be applied in our country.

Innovations Prior work focuses on how managers benefit from an increase in stock price without considering the economic consequences of any corresponding changes in firm risk, the author considered. The author decompose vega into two components: the component correlated with recent performance (VegaPerf) and the component uncorrelated with recent performance decompose total portfolio vega into the vega from previously granted options (VegaOld) and the vega of new options granted during the year (VegaNew).

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