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Stock option compensation and the likelihood of meeting analysts' quarterly earnings targets

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  • Mark Bauman
  • Kenneth Shaw

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    Abstract

    One role of stock options in executive compensation packages is to counterbalance the inherently short-term orientation of base salary and annual bonuses. Managerial compensation plans frequently include stock options in order to better align the interests of managers and outside shareholders and reduce agency problems. However, since option values are sensitive to fluctuations in stock prices, and investors reward firms that meet or exceed earnings expectations, executives of firms with sizable option components in their compensation plans have increased incentives to report earnings that meet or exceed analysts' forecasts. We show that the propensity to meet or exceed analysts' quarterly earnings forecasts is positively related to the use of options in top executives' compensation plans. Further, firms that employ relatively more options in their compensation plans more frequently report earnings surprises that exceed analysts' forecast by small amounts (between 0 and 1 cent per share). These results suggest that the use of stock-based compensation intensifies top executives' focus on financial analysts' short-term earnings forecasts. Copyright Springer Science + Business Media, Inc. 2006

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    File URL: http://hdl.handle.net/10.1007/s11156-006-7435-1
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    Bibliographic Info

    Article provided by Springer in its journal Review of Quantitative Finance and Accounting.

    Volume (Year): 26 (2006)
    Issue (Month): 3 (May)
    Pages: 301-319

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    Handle: RePEc:kap:rqfnac:v:26:y:2006:i:3:p:301-319

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    Web page: http://springerlink.metapress.com/link.asp?id=102990

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    1. Rajgopal, Shivaram & Shevlin, Terry, 2002. "Empirical evidence on the relation between stock option compensation and risk taking," Journal of Accounting and Economics, Elsevier, vol. 33(2), pages 145-171, June.
    2. Brown, Lawrence D., 1991. "Forecast selection when all forecasts are not equally recent," International Journal of Forecasting, Elsevier, vol. 7(3), pages 349-356, November.
    3. Degeorge, Francois & Patel, Jayendu & Zeckhauser, Richard, 1999. "Earnings Management to Exceed Thresholds," The Journal of Business, University of Chicago Press, vol. 72(1), pages 1-33, January.
    4. Graham, John R. & Harvey, Campbell R. & Rajgopal, Shiva, 2005. "The economic implications of corporate financial reporting," Journal of Accounting and Economics, Elsevier, vol. 40(1-3), pages 3-73, December.
    5. Bartov, Eli & Givoly, Dan & Hayn, Carla, 2002. "The rewards to meeting or beating earnings expectations," Journal of Accounting and Economics, Elsevier, vol. 33(2), pages 173-204, June.
    6. DeFond, Mark L. & Jiambalvo, James, 1994. "Debt covenant violation and manipulation of accruals," Journal of Accounting and Economics, Elsevier, vol. 17(1-2), pages 145-176, January.
    7. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
    8. Bowen, Robert M. & DuCharme, Larry & Shores, D., 1995. "Stakeholders' implicit claims and accounting method choice," Journal of Accounting and Economics, Elsevier, vol. 20(3), pages 255-295, December.
    9. Hanlon, Michelle & Rajgopal, Shivaram & Shevlin, Terry, 2003. "Are executive stock options associated with future earnings?," Journal of Accounting and Economics, Elsevier, vol. 36(1-3), pages 3-43, December.
    10. Aboody, David & Kasznik, Ron, 2000. "CEO stock option awards and the timing of corporate voluntary disclosures," Journal of Accounting and Economics, Elsevier, vol. 29(1), pages 73-100, February.
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