The effect of a golden parachute on managed earnings

• Published in: Managerial finance Vol. 45; no. 7; pp. 925 - 949
• Main Authors: Ujah, Nacasius U, Okafor, Collins E
• Format: Journal Article
• Language: English
• Published: Patrington Emerald Publishing Limited 08-08-2019; Emerald Group Publishing Limited
• Subjects: Age; Book value; Cash flow; Earnings; Earnings management; Executive compensation; Financial statements; Golden parachutes; Hypotheses; Short term; Standard deviation; Stockholders; Wages & salaries; United States > US; Managed earnings; Golden parachute; Pay for performance; Executive compensation
• ISSN: 0307-4358; 1758-7743
• DOI: 10.1108/MF-02-2017-0041

Purpose
The purpose of this paper is to investigate the influence of executive compensation on the propensity to manage earnings. In particular, the authors examine an executive contractual clause known as a golden parachute (hereafter GP is interchangeably used). Usually, the triggering of a GP occurs for the following reasons: in a takeover, in termination of employment, and if the executive remains with the company through a recessionary cycle. Specifically, the authors ask the following questions: for firms that their CEO have a GP, do these firms manage earnings more? Does the age of the CEO matter for firms that have adopted a GP concerning the managing earnings?
Design/methodology/approach
The sample is based on a review of the literature on GPs and managed earnings. the authors’ data come from COMPUSTAT, CRSP, EXECUCOMP and Risk Metrics, and consist of 1,184 US firms from 1992 to 2011. A GP is binary, whereas the authors represent managed earnings through accruals and real activity.
Findings
The authors find that the propensity to manage earnings varies on the type of methods strategically used. However, controlling for the effect of SOX reveals that GP firms are more likely to manage earnings. Younger CEOs are less likely to exacerbate earnings upward.
Research limitations/implications
The authors are limited to small sample based on when the data were collected.
Practical implications
The evidence shows that GP alleviates CEOs’ concerns on short-term profits. However, it entrenches CEOs. Particularly, CEOs with a GP are more likely to exacerbate earnings. Thus, there is a need for compensation committees to give considerable attention to how GPs are assigned.
Originality/value
To the authors’ knowledge, this is the first study that explores the effect of a GP on a firm’s propensity to manage earnings.