Target ownership plans and earnings management

Abstract

We examine the effect of target ownership plans (TOPs) on earnings management, after controlling for self-selection bias originating from firm characteristics underlying the determinants of TOPs. Our analyses show that firms engage in less accruals management for up to two years following plan adoption. Additionally, we find that the reduction in accruals management is concentrated in adopting firms whose CEOs' ownership levels are increasing because they have not yet met the ownership requirements. Interestingly, we find that TOPs are associated with less use of income-increasing accruals and less real earnings management, particularly through manipulation of discretionary expenditures. Finally, our results suggest that firms adopt TOPs not only in response to poor performance as documented by prior research, but also as a means to mitigate moral hazard concerns and in response to peer pressure. Our findings support the argument that TOPs align CEOs' incentives with shareholders' in that these plans result in reduced management short-termism. Data availabilityAll data used in the study are available from the public sources identified in the text.