Equity-based incentives and opportunistic behavior – Evidence from Finland

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School of Business | Master's thesis
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Executive compensation is a subject of great interest in academic world as well as otherwise. The compensation packages of top management usually consist of fixed and variable pay such as bonus payments and equity-based incentives. Equity-based incentives tie the wealth of the management to the development of the share price. Therefore, equity-based incentives should align the interests of the shareholders and the managers. Previous literature has, however, documented that equity-based incentives may create agency problems of their own. One concern which the previous literature has identified is that executives try to affect their remuneration with earnings management. Thus, this thesis is designed to study accruals-based earnings management in relation to equity-based incentives. Previous literature consists mainly of studies conducted with data from the US. However, the accounting standards in Europe, the IFRS, differs from the one used in the US in many ways. Therefore, this issue should be studied in the context of the IFRS. Multiple IFRS standards require managerial estimates to report the accruals, which creates a fertile ground to manage earnings. This, among other reasons, is why the findings of previous literature based on the US data should not be unreservedly generalized. This is a quantitative study, which uses data for publicly listed Finnish firms, to study accruals-based earnings management prior to the determination of the strike price of a stock option and prior to the receipt of share awards. A uniquely constructed dataset, which contains information for years 2005 - 2019, of multiple sources is used in this study. The data is analyzed using Jones model and modified Jones model which are commonly used in earnings management literature. The regression analyses are done by using panel data and suitable fixed effects models. The results of this study exhibit consistent and statistically significant evidence about income-decreasing discretionary accounting choices prior to the determination of stock option strike price and the receipt of share awards. This type of behavior is motivated by the pursuit to affect the share price. One interesting finding of this study is that no statistically significant differences in reporting patterns can be found between stock option and share award programs. The findings of this study further validate the perception that equity-based incentives not only solve agency problems but instead create them, as well. Furthermore, this study documents that the discretionary accounting choices reverse in a speedy fashion in relation to share award programs. The effect of analyst coverage on opportunistic earnings management is also studied but no statistically significant results are found.
Thesis advisor
Ikäheimo, Seppo
earnings management, discretionary accounting choices, accruals, agency theory, executive compensation, stock options, share awards