Option grants and investor reaction to restatement‐induced litigation

Abstract

PurposeThe purpose of this paper is to examine the relation between CEO option grants at the beginning of the class period (BCP) and investor reaction to announcement of restatement‐induced securities litigation.Design/methodology/approachUsing a restatement‐induced lawsuit sample over the period 1997‐2005, this study performs cross‐sectional linear regressions of three‐day litigation announcement cumulative abnormal returns (CARs) on CEO option grants, cash compensation, corporate governance and control variables. CARs are calculated over the three‐day (−1,1) interval relative to the lawsuit announcement date using a single‐factor market model, the CRSP equally‐weighted market index, and a 255‐day estimation period ending 45 days prior to the announcement.FindingsA negative association is reported between CEO option grants and investor reaction around restatement‐induced lawsuit announcement.Research limitations/implicationsIt is possible that some restatements may have triggered a securities lawsuit but because it was not explicitly stated, they were not included in the restatement‐induced lawsuit sample. Another limitation of the study is that the qualitative aspects of the internal corporate governance variables may not have been sufficiently captured in the analyses.Originality/valueThe reported result suggests that the market considers CEO option grants as an indication that a restatement‐induced securities lawsuit has merit. The finding also implies that although CEO option grants may not be exercised during the class period, the market imposes higher penalties on firms that offer higher equity compensation to their CEOs at the beginning of the class period.