Earnings Restatements, Changes in CEO Compensation, and Firm Performance

By Qiang Cheng, David B. Farber. 2008

217 citations recorded by the source corpus.

ABSTRACT: Prior research finds that earnings restatements are linked to CEOs’ excessive option-based compensation and equity holdings. In this paper, we investigate whether firms that experience earnings restatements recontract with their CEOs to reduce their option-based compensation and if so, whether this leads to improved firm performance. Based on 289 restatement firms over the period 1997–2001, we find that the proportion of CEOs’ compensation in the form of options declines significantly in the two years following the restatement. Furthermore, we document that this reduction is accompanied by a decrease in the riskiness of investments, as reflected in lower stock return volatility and subsequent improvements in operating performance. Our results suggest that a decrease in option-based compensation reduces CEOs’ incentives to take excessively risky investments, resulting in improved profitability. Overall, our findings provide insights into the design and efficacy of CEO compensation contracts.

Subfields: Accounting, Strategy and Management

View Paper: https://www.semanticscholar.org/paper/7f1a75af4c21cd752402e86f77df6a3de5cd9537

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Citations in the corpus

Opaque financial reports, R2, and crash risk (2009, methodology): “We obtain a sample of such restatements from Cheng and Farber (2008), who in turn developed their sample from 919 restatements of public companies between January 1, 1997 and June 30, 2002 identified in a US General Accounting Office (GAO) report.”
Shock-Based Causal Inference in Corporate Finance and Accounting Research (2015, background): “For example, Cheng and Farber (2008) compare the change in CEO option grants for firms that restate earnings with the change for non-restating control firms; Hail and Leuz (2009) compare the change in cost of capital for firms which cross-list in the US to the change in the median cost of capital fo”
Executive Compensation and Corporate Fraud in China (2014, unknown): “Specifically, we estimate a difference in difference pay equation following Cheng and Farber (2008).”
CEO demographics and accounting fraud: Who is more likely to rationalize illegal acts? (2011, background): “…audits and auditors, fraud risk assessments and earnings management (Beasley, 1996; Burns and Kedia, 2008; Carcello and Nagy, 2004a, 2004b; Cheng and Farber, 2008; Dechow et al., 1996; Erickson et al., 2006; Jia et al., 2009; Jones et al., 2008; Laux and Laux, 2009; Prawitt et al., 2009…”
Understanding Earnings Quality: A Review of the Proxies, Their Determinants and Their Consequences (2010, background): “Studies also suggest that expected earnings quality, measured primarily by timeliness, is associated with ex ante compensation contract design, while changes in earnings quality, measured by the incidence of restatement, are associated with ex post recontracting (Bushman et al., 2004; Cheng and Farb”
The Relation between Equity Incentives and Misreporting: The Role of Risk-Taking Incentives (2013, background): “…Cheng and Warfield, 2005); (4) Options, calculated as the number of options granted during the year as a fraction of total shares outstanding (e.g., Cheng and Farber, 2008); and (5) Gamma, calculated as the sensitivity of portfolio delta to changes in stock price (e.g., Burns and Kedia, 2006).”