Misvaluation and Insider Trading Incentives for Accrual‐based and Real Earnings Management

Abstract

Abstract:We investigate the incentives that misvaluation creates for: (1) insider trading; and (2) concurrent earnings management through both accruals and real activities. Managers of overvalued firms have an incentive to sustain overvaluation through income increasing earnings management and, at the same time, to sell their shares (Jensen, 2005). Managers of undervalued firms benefit from buying their firm's shares, however the negative effects of downward earnings management may offset incentives to enhance trading advantages. The results indicate that managers of both over-and under-valued firms act opportunistically, managing earnings upward (downward) with accruals while selling (buying) shares. The Sarbanes-Oxley Act of 2002 (SOX) has been largely ineffective in eliminating trading motivated earnings management. Finally, we do not find evidence of a relationship between managerial trading and real earnings management.

The Influence of a Company’s Ownership Structure on Upward Real Earnings Management

“…Our research thus confirms the alignment of interest hypothesis, but takes the perspective of real earnings management. Consequently, our study contributes to the hypothesis considering the positive relationship between informativeness of earnings and the magnitude of managerial ownership of Dhaliwal et al [20], Warfield et al [3], Ebrahim et al [21], Ali et al [22], and Sawicki et al [29], but it is viewed through the lens of real earnings management, while prior studies analyzed accrual earnings management. In prior studies, the correlations were analyzed between real earnings management and the quality of board governance [80].…”

“…Therefore, we can expect that managerial ownership is negatively correlated with engagement in earnings management. This principle has been confirmed in many empirical studies, including [3,[20][21][22]29]. However, the interests of owners and managers are not identical; therefore, managers who participate in the equity of the company could realize their specific objectives and benefits.…”

“…The links between accounting (accrual) earnings management and ownership structure have been analyzed in many outstanding studies described in the next section, including [3,[15][16][17][18][19][20][21][22][23][24][25]. Research on the relationship between the magnitude of real earnings management and the ownership structure of companies has been much more limited and has not necessarily focused on ownership concentration and managerial ownership, including that of [26][27][28][29][30][31][32][33]. Hsu and Wen [34] analyzed only the linear correlation between the percentage of insider shareholdings and the magnitude of real earnings management.…”

“…The study provides the evidence that a company's ownership structure, including ownership concentration and managerial ownership, influences upward real earnings management practices. Prior studies mostly document the role of managerial ownership in the processes of accounting (accrual) earnings management; therefore, we contribute to [3,[20][21][22]29], but in our study, it is viewed through the lens of real earnings management. The next element of the contribution to the subject literature is the examination of the impact of the degree of ownership concentration in actions monitoring the activity of the enterprise, thereby expanding the research of [26][27][28] in providing evidence that the association between the magnitude of total upward real earnings management and shareholder concentration is U-shaped.…”

Rank and file equity compensation and earnings management: Evidence from stock options

“…Following prior research, we include control variables reflecting firm performance (Hochberg & Lindsey, ; Call et al., ), cash and financial constraints (Core & Guay, ; Sloan, ), firm size and growth (Dechow & Dichev, ), firm visibility (Beneish, ; Dechow, Ge, Larson, & Sloan, ), the extent of stock overvaluation (Sawicki & Shrestha, ; Sloan, ), and characteristics of executive compensation (Hochberg & Lindsey, ; Call et al., ). Our main analyses also include firm and year fixed effects to control for persistent firm effects and year‐specific factors that may correlate with the measures of earnings management.…”