Does Stock-based Incentive Plan Motivate Earnings Management?

Management compensation incentive policies are designed as an incentive tool for senior management to realize the goal set by companies or achieve goal congruence, so as to maximize the stockholders’value. There is a lot of evidence about how to plan the compensation incentives in both academic and practical way. Based on the literature review, since the first announcement of agency cost by Jensen and Meckling in1976, stock-based compensation incentive has been a frequent topic. It is stated that stock-based compensation incentive associates the financial risk posted by management and the stock price, then congruent the operation plan and future outlook between management and stockholders. This specific compensation incentive can lower the agency cost and the risks of moral hazard. However, the evidence shows that this theoretical incentive also has some side-effects, such as the motivation for management to manipulate the accruals to achieve higher bonus.Since China started equity division reform, a set of management compensation incentive regulations have been carried out, such as Listed companies stock-based incentive approach and state-owned listed companies’ incentive plan approach. Since these regulations were put in practice, leaded by state-owned listed companies, quite a few listed companies started plan the management incentive plan, and the main incentive tool is stock option. The efficiency of capital market is improved, the regulation over listed companies is enhanced, but does the management incentive plan in listed companies in China have any side-effect? Since the number of listed companies which announced stock-based incentive plans rises up dramatically, there are more data in recent4year to improve the evidence. As a result, this paper examines if the stock-based incentive plan motivates the earnings management. Again, this paper examines the effects on management trading by stock-based incentive plan.This paper collected a sample from2007to2010non-financial or electricity companies A share listed companies. To begin with, this paper examines whether the stock-based incentive plan would motivate more inside trading. Consist with the literature; the result indicates that with more stock-based incentive on management, there are more inside trading such as selling the stocks and exercising the stock options. Based on this result, this paper uses a dummy variable, if the actual earnings per share just beats or meets the analysts forecast. This paper groups the sample into two groups, whether the actual earnings per share just beats or meets the analysts forecast. In two different groups, both results show that actual earnings per share deviates from analysts forecast. Based on the comparison between two groups, the significance of negative relation is more remarkable in the group which the actual earnings per share only just beat or meets the analysts forecast. In conclusion,(1) Management with higher stock-based incentive are more likely to sell the stocks or exercise the options.(2) Given the rational earnings management in the analysts forecast, the performance of companies still deviates from the analysts forecast.(3) When the actual performance is better than the analysts forecast, more earnings management exists.In detail, this paper contains five parts:Part one is the introduction. This part introduces the study background, the study methodology and structure of this paper. The creation also is contained in this part.Part two is the literature review. Based on the equity incentive theory, this part states the information asymmetry and agency theory. Besides the theories, this parts also includes the changes in the regulation in recent years. Based on the recent study on the equity incentive, this part concludes the outcomes of the equity incentive plans, and then dives into the details of earnings management study. At last, this part also makes a conclusion about the literaturePart three analysis the theory and assumptions. Based on the two conditions that managers can make short-term arbitrage, two consistent assumptions are listed in this part.Part four states the empirical research design and outcomes. This part starts with the data, introduces the models, variables. The results of all sample and two different groups are stated in this part. Besides, this part makes the analysis of the results. Part five states the conclusion and the advices. Based on the specific conclusion, this part contains the regulation suggestions.There might be two creations of this paper.This paper did not use the Jones models to measure the earnings management, but a dummy variable, whether actual earnings just meets or beats the analyst forecast.This paper uses a variable introduced by Bergstresser and Philippon to measure the incentive. This variable measures the change in incentive with1%change in share price.There still are some flaws in this paper that could not be avoided. First of all, given most of the recent study uses the Jones model, this paper lacks certain comparability. Second, this paper did not dive into the comparison between state-owned or non-state-owned companies. Because the state-owned company has more social responsibilities such as tax or employment, the motivation for managers in state-owned company might deviates from the other. Third, this paper did not differentiate between different incentive tools.