Insurer Reserve Error and Executive Compensation

Earnings Smoothing, Executive Compensation, and Corporate Governance: Evidence From the Property–Liability Insurance Industry

“…The models were estimated using both measures of reserve error discussed above 38 . These results support the findings in Eckles and Halek (2010). As predicted, the coefficient on RSTKAW is significant and negative in both specifications, supporting H1.…”

“…Prior research has documented the manipulation of insurance accounting results for various reasons, including avoiding regulatory scrutiny (Grace, 1990; Petroni, 1992), smoothing tax liabilities (Grace, 1990; Petroni, 1992; Petroni and Shackelford, 1999), and increasing the compensation of executives (Healy, 1985; Holthausen, Larcker, and Sloan, 1995; Eckles and Halek, 2010). 2 There also exists a literature investigating the oversight capacity that corporate governance mechanisms have in mitigating executives’ manipulation of earnings (see Klein, 2002; Xie, Davidson, and DaDalt, 2003; Peasnell, Pope, and Young, 2005).…”

“…In the accounting literature, Healy (1985), Gaver, Gaver, and Austin (1995), and Holthausen, Larcker, and Sloan (1995) link the bonus component of executive compensation with earnings management through accruals 3 . In the insurance literature, Eckles and Halek (2010) find evidence that incentive‐based components of executive compensation are positively associated with earnings manipulations. Similarly, Browne, Ma, and Wang (2009) show significant correlation between insurer reserve errors and the options granted to executives.…”

“…Second, this research expands the current limited understanding of corporate governance in the insurance industry specifically. Despite the abundant evidence of loss reserve manipulation among property–liability insurers (Petroni, 1992; Beaver, McNichols, and Nelson, 2003; Gaver and Paterson, 2000, 2004) and the link between executive compensation and earnings management (Healy, 1985; Holthausen, Larcker, and Sloan, 1995; Eckles and Halek, 2010), no prior research in the insurance literature has investigated how insurers’ loss reserve practices are affected by the joint impact of executive compensation incentives and board structure. Further, this is the first article that uses reserve errors to observe the initial impact of the Sarbanes–Oxley Act (SOX) on corporate governance in the insurance industry.…”

“…11 11 The executives in our sample are also given bonuses termed “long‐term incentive plans,” which are essentially bonuses paid in 1 year based upon performance in multiple prior years. We remove these bonuses from consideration, since prior research has found them to be insignificant with respect to reserving practices (Eckles and Halek, 2010) and since they make up a very small proportion of the executive compensation packages for our executives (around 4 percent of total compensation). …”