Abstract
Synthesizing agency theory and prospect theory, we examined the effects of stockbased incentives on CEO earnings manipulation behaviors. In analyses of data compiled from the public companies listed in Compustat’s Executive Compensation Database and a U.S. General Accounting Office restatements database, we found that CEOs were more likely to manipulate firm earnings when they had more out-of-the-money options and lower stock ownership. Firm performance and CEO tenure interacted with out-of-the-money options and ownership to influence CEO earnings manipulation behaviors. Our findings inform agency-based views by providing evidence that, under certain conditions, stock-based managerial incentives lead to incentive misalignment. Inappropriate behavior by management (e.g., earnings manipulation, fraudulent financial reporting) has long been an important area of interest to scholars, regulators, investors, and the public at large. The recent high-profile scandals at Enron, Tyco, and WorldCom have drawn increased attention to earnings manipulation activities (Levitt,
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