Why do corporate managers misstate financial statements? The role of option compensation and other factors

• Published in: Journal of financial economics Vol. 85; no. 3; pp. 667 - 708
• Main Authors: Efendi, Jap, Srivastava, Anup, Swanson, Edward P.
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01-09-2007; Elsevier; Elsevier Sequoia S.A
• Series: Journal of Financial Economics
• Subjects: Agency theory; Business management; Chief executive officers; Compensation; Executive compensation; Financial incentives; Financial reporting; Financial restatements; Financial statements; Options on stocks; Probability; Restatements; Stock options; Studies; Stock options; Restatements; G34; M41; M52; J33; Executive compensation; Agency theory
• ISSN: 0304-405X; 1879-2774
• DOI: 10.1016/j.jfineco.2006.05.009

We investigate the incentives that led to the rash of restated financial statements at the end of the 1990s market bubble. We find that the likelihood of a misstated financial statement increases greatly when the CEO has very sizable holdings of in-the-money stock options. Misstatements are also more likely for firms that are constrained by an interest-coverage debt covenant, that raise new debt or equity capital, or that have a CEO who serves as board chair. Our results indicate that agency costs increased [Jensen, M.C., 2005a, Agency costs of overvalued equity. Financial Management 34, 5–19] as substantially overvalued equity caused managers to take actions to support the stock price.