Executive stock options and earnings management in the portuguese listed companies

Abstract

Theoretically, executive stock options align managers’ and shareholders’ interests. However, previous studies have indicated that stock options may engender manager-shareholder conflicts (Jensen, 2005) and create incentives for earnings management (e.g. Jensen, Murphy and Wruck, 2004; Burns and Kedia, 2006; Efendi, Srivastava and Swanson, 2007). Therefore, this paper examines the implications of stock option grants on earnings management. In particular, we address the following question: Does stock options grant induce incentives for earnings management? Using a sample of 33 non-financial listed Portuguese firms-year from 2003 to 2010, we find that managers are more likely to engage in earnings management when they hold stock options. This study suggests that stock options may not always be effective in aligning the interests of managers and shareholders. Rather, executive stock options seem to affect the informational quality of earnings negatively, and consequently reduce the quality and value relevance of published financial data.