Executive Stock Options, Missed Earnings Targets, and Earnings Management

1
Executive Stock Options, Missed Earnings Targets,
and Earnings Management

• Mary Lea McAnally, Anup Srivastava
• and,
• Connie D. Weaver

2
Discussion Topics

• Objective
• Motivation
• Prior Research
• Sample
• Method
• Hypotheses
• Results
• Inferences
• Contribution

3
Objective

• Examine whether or not stockoption grants
  explain missed earnings targets, included
  reported losses, earnings declines, and missed
  analysts forecasts.

4
Motivation

• Desire to answer the question Do option grants
  give management incentive to miss earnings
  targets?

5
Prior Research

• Direct extension of Balsam, Chen, and
  Sankaraguruswamy (2003)
• Baker, Collins, and Reitenga (2003)
• Burgstahler and Dichev (1997)

6
Sample

• Data gathered from ExecuComp, Compustat, CRSP,
  and IBES.
• Annual data from 1992 to 2004.
• Missed earnings targets are measured.
• Firms that miss positive earnings target.
• Firms that miss prior-year earnings target.
• Firms that miss analysts forecasts.

7
Sample
8
Sample
9
Sample
10
Sample
11
Method

• Multivariate logistic regression using annual
  data.
• Missit ß0 ß1Grants SCEO_Incentivekit
  SControlsit eit
• CEO Incentive
• Exercises, options, stock, and bonus.
• Control
• Gap_to_grant, growth, leverage, and industry
  fixed effects.

12
Method

• Treats bad news endogenously, whereas many
  studies before have treated bad news as
  exogenous.

13
Hypotheses

• H1 Executive stock-option grants are unrelated
  to missed earnings targets.
• H2 Large fixed-date stock-option grants
  increase the likelihood that CEOs manage earnings
  downward and miss earnings targets.

14
Results H1
15
Results H1-Fixed Sample Only
16
Results H1

• Their results
• Positive coefficient for Grants all 3 miss
  categories.
• My results
• Did not have a positive coefficient for Grants
  miss analyst.

17
Results H2 Abnormal Accrls
18
Results H2 Deferred Taxes
19
Results H2

• Their results
• Positive coefficient for Grants all 3 miss
  categories.
• My results
• Did not have a positive coefficient for Grants
  miss prior year or miss analyst.

20
Inferences

• The likelihood of missing earnings targets for
  firms that manage earnings downward increases
  with the CEO stock-option grants.
• CEOs act in their best interest rather than the
  interest of the stock holders when they
  anticipate being awarded a large stock option.
• CEOs will not miss earnings targets year after
  year for fear of losing their job

21
Contribution

• First paper to consider that managers
  intentionally miss earnings targets to make stock
  options more personally profitable
• Bad news is treated as endogenous rather than
  exogenous (CEOs are creating the bad news)
• Looks at both grants and exercises and or option
  holdings (incentive to manage earnings both ways)

22
Contribution

• Demonstrate that meeting or beating an earnings
  target is not a necessary condition for earnings
  management
• Supports opportunistic timing of grants by
  giving earnings management as one more
  explanation of missed earnings targets