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

Abstract

Unlike studies that estímate managerial bias, we utilize a direct measure of managerial bias in the U.S. insurance industry to investigate the effects of executive compensation and corporate governance on firms' eamings management behaviors. We find managers receiving larger bonuses and stock awards tend to make reserving decisions that serve to decrease firm earnings. Moreover, we examine the monitoring effect of corporate board structures in mitigating managers' reserve manipulation practices. We find managers are more likely to manipula te reserves in the presence of particular board structures. Similar results are not found when we employ traditional estimated measures of managerial bias.

Actuarial Independence and Managerial Discretion

“…Managerial compensation incentives could play a significant role in managerial behavior. Taking a broader view into the corporate finance literature, managerial incentives seem to play a significant role with respect to earnings management (e.g., Cheng and Warfield, 2005;Bergstresser and Philippon, 2006;Eckles et al 2011) and tax incentives (Rego and Wilson, 2012). Focusing on the sample of publicly traded PC insurers from 1992 to 2000, Eckles and Halek (2010) find that insurance executives manage reserves to increase their compensation over a short-term horizon (typically 1-2 years).…”

“…However, earnings' smoothing may not be the only hypothesis related to earnings management. Compensation incentives have also been linked to earnings management (e.g., Cheng and Warfield, 2005;Bergstresser and Philippon, 2006;Eckles et al, 2011). Eckles and Halek (2010) show that insurance executive manage earnings to increase their compensation in the short run.…”

How Accurately Can Z‐score Predict Bank Failure?

“…4 However, as well spelled out in these studies, the Altman's (1968) Z-score 3 In this sense, our study is also related to Jin et al (2011) who develop six and ten accounting and audit quality variables to predict whether banks failed during the financial crisis starting from 2007. For recent studies on managerial incentives that give rise to earnings smoothing for financial industries, see Cheng et al (2011) andEckles et al (2011), and for discussions on how regulations could change earnings smoothing incentives for bank managers, see Kilic et al (2012). 4 The variables used in his 1968 seminal study are: (1) working capital/total assets, (2) retained earnings/total assets, (3) earnings before interest and taxes/total assets, (4) market value equity/book value of total liabilities, and (5) sales/total assets.…”

“…() and Eckles et al . (), and for discussions on how regulations could change earnings smoothing incentives for bank managers, see Kilic et al . ().…”

Loss reserving behaviour in insurance markets: Evidence from Mauritius

“…The discretion of principals in managing firms earning through the manipulation of accounting figures in the financial statements has been widely investigated in both financial (Eckles, Halek, He, Sommer, & Zhang, 2011;Kamiya & Milidonis, 2016;Kelly, Kleffner, & Li, 2012) and nonfinancial firms (Adut, Holder, & Robin, 2013;Bao & Lewellyn, 2017;Datta, Iskandar-Datta, & Singh, 2013;Graham, Harvey, & Rajgopal, 2005). In insurance markets, the bias of management in the manipulation of accounting information is reflected in the reserves provisions, which are required for both past and future exposure to losses.…”