Do CEO Stock Options Prevent or Promote Fraudulent Financial Reporting?

Trust Repair After An Organization-Level Failure

“…We do not anticipate that every component will be implicated; rather, failures of a magnitude that threaten the organization's legitimacy will have multiple contributory causes. This premise is supported by systems and multilevel theory and by research and case studies on organizational failures and crises (see Haunschild & Sullivan, 2002;O'Connor et al, 2006;Pearson & Clair, 1998;Rivkin & Siggelkow, 2003). 2 We distinguish the role of internal and external system components in organizational failures.…”

CEO Inside Debt and Earnings Management

“…However, using post-SOX data (2002)(2003)(2004)(2005)(2006), Jiang et al (2010) find no effect of CEO and CFO equity incentives on |DA| and the likelihood of meeting or beating analysts' forecasts. Recent evidence shows that CEO equity incentives can even deter earnings restatement (e.g., Armstrong et al, 2010;O'Connor, Priem, Coombs, & Gilley, 2006) or reduce signed DA (H. Kim, Kwak, & Suk, 2013), suggesting that equity-based compensation alleviates managers' opportunistic behaviors by aligning managers' interests with shareholders'. Hence, we make no predictions on the expected signs of the coefficients for these variables.…”

Providing CEOs With Opportunities to Cheat

“…These arguments indicate that stock options can provide managers with incentives for misrepresenting their firms' financial performance to boost near-term compensation (Harris & Bromiley, 2007) or to cover up risky bets gone wrong (O'Connor et al, 2006). Top managers will be more likely to engage in financial reporting fraud when the easy opportunity afforded by information asymmetry occurs jointly with the motivation generated by higher stock options incentive compensation.…”

“…Studies examining CEO compensation and financial reporting fraud indicate that large stock option incentives, especially, may motivate CEOs to misreport financial results. For example, the likelihood of financial misconduct increases with a higher percentage of CEO compensation received from stock option grants (Harris & Bromiley, 2007), with a greater amount of "out of the money" CEO stock options (Zhang et al, 2008), and when boards of directors (BoDs) also have incentive compensation plans (O'Connor et al, 2006). Thus, incentive-aligning stock option compensation intended to reduce agency monitoring costs and improve firm performance may, when taken to extremes, instead promote financial reporting fraud (Desai, Hogan, & Wilkins, 2006;see Armstrong, Jagolinzer, & Larcker, 2010, for a contrary view).…”

“…The societal cost of this worldwide spate of financial reporting fraud has led researchers and regulators to call for a fundamental reexamination of corporate governance and regulation (e.g., O'Connor, Priem, Coombs, & Gilley, 2006;Paulson, 2007;Zhang, Bartol, Smith, Pfarrer, & Khanin, 2008).…”