Are Incentive Stock Options Signaling Better Corporate Governance? - An Evidence from Equity Carve-Outs

Abstract

I analyze the long-run performance and earnings management behavior of equity carve-outs conditioned on whether the executives received incentive stock options at the IPO date. Carve-outs that did not grant incentive stock options subsequently underperform both relative to the overall market and relative to a sample of carve-outs that granted stock options. I show that in absence of incentive stock options, companies adopt more income-increasing Accounting techniques around the IPO. Accruals in years around the IPO explain the cross-sectional variation of the long-run stock market and accounting underperformance. Contrarily, carveouts that grant incentive stock options to their executives at the IPO date do not underperform appropriate benchmarks over three-year period following the IPO and use less aggressive accounting around the IPO. My results point that incentive stock options are signaling better corporate governance to the market that result in better long-run stock market and accounting performance.