has a negative relation and that bonus and stock-based compensation have a positive relation with discretionary accruals as a tool for earnings management. To test this, accrual and compensation data from FTSE listed firms is used. The accrual approach will be used in measuring earnings management and the relative size of the compensation types will be used to measure the compensation variables. The results from this research show that fixed salary has a positive relationship with discretionary accruals. For bonus compensation no linear relationship with discretionary accruals is found and for stock-based compensation a negative relationship with discretionary accruals is found. Moreover, this research has proven that low equity incentive CEO’s have significant higher mean scores of discretionary accruals than high equity incentive CEO’s. Therefore, the results seem to oppose the results of studies from Bergstresser and Philippon (2006), Cheng and Warfield (2005) and Gao and Shrieves (2002) who all found evidence that high equity incentive CEO’s engage more in earnings management (through the use of discretionary accruals) than low equity incentive CEO’s. Table of Contents
Appendix A Summarization of the empirical findings of prior research. Author(s) Year Title paper Journal Object of study Sample (sample size, country, research period) Methodology Results #1 Cheng Q., D.B. Farber 2008 Earnings restatements, changes in CEO compensation, and firm performance The Accounting Review Compensation contracts of CEO’s following an earnings restatement. The sample size of this study is 289 restatements from the period of 1997 to 2001 from companies who are listed at the NYSE, the AMEX or the Nasdag. For each restatement firm compensation data is collected. First the pre- and levels of restatement firms' CEO option grants is compared to calculate the change in option grants around restatements. Then this change is compared to the change in option grants for control group over the same period. Furthermore, there is examined whether the reducting in option-based compensation leads to improved performance. Restatement firms, compared to control firms, reduce the proportion of CEO’s total compensation that is following a restatement. Thus, restatements firms are likely to view reducing compensation as an important means of reducing their agency problems. Furthermore, the authors find evidence of improved operating performance following the reduction in option-based compensation.
reward management with equity -based compensation, i.e. stock options. #8 Bauman M.P., K.W. Shaw 2006 Stock option compensation and the likelihood of meeting analysts' quarterly earnings targets Review of quantitative finance and accounting The relation between stock options employed in a firm's executive pay plan and the firm's propensity to meet or beat analysts' earnings forecasts. 2,513 firms top 5 executives from the years 1992-2002. Earnings per share is set off against analyst forecast (MEET) and if difference is between 0 and 1 cent per share (SHARE). Firms that employ higher amounts of stock option compensation in their top executive pay schemes more frequently meet or beat analysts' quarterly earnings targets, and more frequently report small earnings surprises, than firms with lower stock-based compensation. #9 Roychowdhury,S. 2006 Earnings management through real activities manipulation Journal for Accounting and Economics Contributes to the literature on earnings management by presenting evidence on the management of operational activities. Prior literature focuses more on detecting abnormal accruals. All firms in COMPUSTAT between 1987 and 2001 that have sufficient data available for the calculations needed. Data is analyzed is taken from annual figures. In total 17,338 firms year spread over 3,672 firms Based on the model of Dechow, normal levels for CFO, production costs and discretionary expenses are attained for each firm. Deviations from normal levels are termed abnormal. These firms are stated suspect firms. The three different categories are to establish weather or not there in differences in the managerial decisions or operational activities, rather that reported activities. The results complement existing literature on earnings management. Methods have been developed to detect real activity manipulation in large samples. The paper also detects activity manipulation around earnings threshold, particularly the zero threshold. Furthermore, insights are given into the factors of activity manipulation.