Chief Executive Officer Incentives and Earnings Management Case Study

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Updated: Jan 19th, 2024

Summary

Key Idea

The article under analysis is devoted to the examination of the discretionary accruals from the perspective of their application to the reported earnings handling. Daniel Bergstresser and Thomas Philippon put a particular emphasis on the aspect of the CEO’s financial incentives and their interconnection with the general financial management (513). The authors also try to indicate the impact that shares’ selling has on the level of accruals. Hence, the principle idea of the article resides in the fact that largely incentivized CEOs are more inclined to control reported measures of performance, and tend to cash in the equity in those cases when the reported earnings show to be too high.

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According to the researchers, the key purpose of their study is to provide empirical proof of the fact that the implementation of discretionary accruals aimed at regulating reported earnings is more frequent with the firms the CEO’s total compensation of which is consistently connected to the stock value and option holdings (Bergstresser and Philippon 515).

Research

The research studies a series of variables. Thus, in the course of the research, the authors measure share sales, accruals, CEO option exercise, and CEO incentives. The researchers employ the Compustat dataset to measure accruals. The relevant method allows sampling of public corporations and their financial information. Moreover, Bergstresser and Philippon use the so-called “firm-year level” measures to assess the size of earnings and cash flows as well as to identify the age of the firm and its place in the relevant industrial classification (516).

The principle variables such as CEO’s incentives and option exercises are evaluated with the help of the so-called “Executive Compensation database”. Lastly, the data concerning purchases and sales performed by executives is retrieved from SEC insider filings that can be accessed through Thomson Financial. The researchers provide a statistical table to show the interconnection between the targeted variables.

Findings

The findings that the authors provide are divided into two parts. Hence, the first section is aimed at evaluating the interconnection between CEO financial incentives and financial management in the framework of the 1990s. From this perspective, the researchers state that accruals are frequently actively employed at the firms the CEO compensation of which is tightly bound to the stock value. The section of the results provides empirical evidence of the fact that the periods of high accruals coincide with those periods when CEOs and other members tend to sell shares or their exercising options.

On the whole, the authors’ findings suggest that the incentivized executives show to be more likely to regulate the measures of performance as well as to cash in their equity while the reported earnings remain exclusively high.

Conclusion

The authors conclude that those CEOs that show to be more ”incentivized” lead companies with higher levels of earnings management. The researchers point out that this group of CEOs is represented by those whose general compensation is more susceptible to the share prices of the company. They, likewise, note that the periods of high accruals are typically accompanied by exclusively considerable option exercises by CEOs. In the meantime, they emphasized the fact that this assumption does not essentially signify that financial incentives ruin average value, though it means that to make an effective use of such incentives, it is necessary to carry out a thorough analysis of their potential strengths and weaknesses (Bergstresser and Philippon 527).

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Works Cited

Bergstresser, Daniel and Thomas Philippon. ” CEO Incentives and Earnings Management.” Journal of Financial Economics 80.1 (2006): 511-529. Print.

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IvyPanda. (2024, January 19). Chief Executive Officer Incentives and Earnings Management. https://ivypanda.com/essays/chief-executive-officer-incentives-and-earnings-management/

Work Cited

"Chief Executive Officer Incentives and Earnings Management." IvyPanda, 19 Jan. 2024, ivypanda.com/essays/chief-executive-officer-incentives-and-earnings-management/.

References

IvyPanda. (2024) 'Chief Executive Officer Incentives and Earnings Management'. 19 January.

References

IvyPanda. 2024. "Chief Executive Officer Incentives and Earnings Management." January 19, 2024. https://ivypanda.com/essays/chief-executive-officer-incentives-and-earnings-management/.

1. IvyPanda. "Chief Executive Officer Incentives and Earnings Management." January 19, 2024. https://ivypanda.com/essays/chief-executive-officer-incentives-and-earnings-management/.


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IvyPanda. "Chief Executive Officer Incentives and Earnings Management." January 19, 2024. https://ivypanda.com/essays/chief-executive-officer-incentives-and-earnings-management/.

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