經理人之股份基礎給付對穩健原則之影響

國立臺灣大學管理學院會計學研究所 碩士論文

Graduate Institute of Accounting College of Management

National Taiwan University Master Thesis

經理人之股份基礎給付對穩健原則之影響

Executives’ Equity-Based Compensation and Accounting Conservatism

楊于萱

Yang, Yu-Hsuan

指導教授﹕劉啟群 博士 Advisor: Liu, Chi-Chun, Ph.D.

中華民國 103 年 6月

June, 2014

謝辭

本論文能順利完成，首先要感謝的是我的指導教授 劉啟群老師。感謝老師 在公事繁忙之際，仍撥空指導學生論文上的疑惑及困難，老師的耐心與鼓勵使我 得以順利完成論文。此外，要感謝 林純央教授以及 廖懿屏教授盡心審閱本篇論 文，並對本篇論文提出諸多寶貴意見，使得本篇論文更為充實完整，在此至上由 衷謝意。

論文研究的這段期間，感謝家人給予我的支持，使我能安心順利完成學業;

感謝會計實證研究方法這門課的 戚務君教授 以及 李彥蓉教授，這堂課所學到 的統計軟體及回歸解釋，對研究資料的收集、整理和回歸分析上有很大的幫助;

感謝朱玉芳學姊給予我許多幫助，提供不同的想法幫我突破盲點;感謝我的摯友、

同窗們以及曾經關心、鼓勵過我的朋友，因為你們使我有勇氣與信心可以完成碩 士論文。

楊于萱 謹識 於台大會計學研究所 民國 103 年 6 月

中文摘要

本篇論文研究目的是探討經理人的權益薪酬比例與公司會計穩健原則之關 係。當公司所有權與經營權分離時，股東與經理人會因資訊不對稱而有代理問題 產生，而給予經理人股票選擇權及限制性股票這類權益薪酬，目的是為了連結雙 方的利益，激勵經理人以公司的利益為主要考量，進而減緩代理問題;穩健會計 就 Watts 契約面解釋而言，認為它能限制經理人的行為，是為了解決因資訊不對 稱、有限期間與有限責任所導致的道德危機，而發展出的一種有效率的機制，可 藉由認列損失與利得時存在的不對稱時效性來降低代理成本，所以我預期經理人 的權益薪酬比例與穩健會計間存在負向關係。

實證研究以美國公司為樣本，採用 Basu 模型，以盈餘對好（壞）消息之不 對稱反應來衡量會計穩健原則，1993-2012 年間證實隨著權益薪酬比例的增加會 降 低 對 穩 健原 則 的 需求 。 本研 究 進一 步 將 樣 本分 為 四 個期 間 : 1993-2001, 2003-2005, 2006-2008, 2009-2012，其中，2003-2005 及 2006-2008 之實證結果亦 符合預期，惟 1993-2001 與 2009-2012，其實證結果之方向雖與預期一致，但不 顯著，可能受該期間有關薪酬之會計制度及股票大盤走勢的影響。最後，各期間 經敏感性測試所得到的實證結果仍不變。

關鍵字:經理人之權益薪酬;會計穩健原則;不對稱時效性;代理問題

Abstract

This paper examines the relation between executives’ equity-based compensation

and accounting conservatism. Since both mechanisms may mitigate the agency

problems between managers and shareholders, I hypothesize that there is a negative

relation between the proportion of equity-based compensation to executives and the

level of conservatism. Using a large sample of US firms during the period 1993-2012,

I find that the coefficient of interaction on the ratio of executives’ equity-based to

total compensation and accounting conservatism is negative and significant. Further, I

divide the whole sample period into four parts: 1993-2001, 2003-2005, 2006-2008,

and 2009-2012. The results of period 2003-2005 and 2006-2008 are consistent with

my hypothesis: the asymmetric timeliness of earnings declines with managerial

proportion of executives’ equity-based compensation. However, the outcomes of

period 1993-2001 and 2009-2012 are negative but not significant. The reason might

be that accounting standard at that time is associated with adoption and shareholders’

understanding of managers’ incentives plan. Besides, the trend of stock market may

bring about an unobvious effect. The results are robust after controlling for the

investment opportunity set and additional tests.

Keywords: executives’ equity-based compensation; accounting conservatism;

asymmetric timeliness; agency problem

Contents

口試委員會審定書………... i

謝辭………...ii

中文摘要………..iii

Abstract……….iv

1. Introduction………...1

2. Related Research and Hypothesis Development………...4

3. Research Design………...8

3.1 The measure of executives’ compensation…..………..8

3.2 The measure of accounting conservatism………..8

3.3 Empirical model………9

4. Sample Selection and Descriptive Statistics………...12

5. Empirical Results……….………...16

6. Sensitivity Analysis……….31

6.1 The effect of the investment opportunity set (IOS)……….31

6.2 Returns in the two ends of the bell curve………35

6.3 Results excluding NAICS 22&52, First 6 NAICS without 22&52………….38

6.4 Results of stock options………...……….38

7. Conclusion……….……….43

References……….……...45

Appendix A………..47

Appendix B………...50

Appendix C………...54

Tables

Table 1……….……….……...13

Panel A: Sample selection……….…13

Panel B: Samples classified by fiscal year and by industry………...………13

Table 2: Descriptive Statistics………...……….……..14

Table 3: Correlation Table……….………..15

Table 4: Test of Basu’s Model……….……16

Table 5: Test of Hypothesis (ECOMP, 1993-2012) ………...19

Table 6: Test of Hypothesis (ECOMP) ……….…..23

Table 7: Test of Hypothesis (logT5EBC) ………29

Table 8: Sensitivity Analysis (IOS) ……….………33

Table 9……….……….……...36

Panel A: Return’s quartile……….…36

Panel B: Sensitivity analysis (Returns in the two ends of the bell curve)…….…36

Table 10: Results excluding NAICS 22&52, First 6 NAICS without 22&52……….39

Table 11: Test of Hypothesis (S) ……….……….…..41

Figure

Figure 1: The mean of ECOMP (1993-2001)……….………...26

1

1. Introduction

The purpose of this study is to investigate whether executives’ equity-based

compensation and the structure of executives’ compensation has an effect on firm’s

accounting conservatism policy. According to prior research, executives’ equity-based

compensation may help in aligning the interests of managers and shareholders. An

incentive compensation system for executives or to give them stock options can be

used to partly alleviate the agency problems (Ahmed et al. 2002; Jensen and Meckling

1976). Meanwhile, accounting conservatism is another way to help mitigate the

agency costs by asymmetric timeliness of earnings (Watts 2003). Therefore, I predict

that equity-based compensation to executives will decrease the need of reducing

information asymmetry using conservative accounting.

In this paper, following Murphy (1999) specification, executives’ pay packages

contain four basic components: a base salary, an annual bonus tied to accounting

performance, stock options, and long term incentive plans (including restricted stock

plans and multi-year accounting-based performance plans). Generally speaking,

executives’ compensation can be classified into two types: one is earning-based

compensation including basic salary and annual bonus; the other is equity-based

compensation including stock options and restricted stock.

Regarding conservatism, accountants traditionally express it by the rule

2

“anticipate no profits, but recognize all losses”. Basu (1997) redefines the

conservatism principle in accounting as the more timely recognition in earnings of

bad news than good news. Watts (2003) interprets “differential verification” as the

greater the conservatism, the greater the difference in degree of verification required

for gains versus losses. He further provides alternative explanations for conservatism,

namely accounting regulation, taxation, shareholder litigation, and contracting. Under

the contracting explanation, conservative accounting is a means of mitigating the

agency problems between managers and shareholders. It is a mechanism increases the

efficiency of contracts between managers and shareholders. Even more, Iyengar and

Zampelli (2010) indicates that conservatism limits earnings management

opportunities and ties executive compensation contracts more closely to accounting

performance. Even though Watts (2003) reveals that such contracts are a main factor

behind the demand for accounting conservatism, there is little empirical research that

examines the relation between executives’ compensation contracts and accounting

conservatism. Most of previous research focuses on debt contracts (Ahmed et al., 2002;

Zhang, 2008; Ball et al., 2008; Beatty et al., 2008) or on earning-based compensation

contracts. However, the composition of executive pay in the U.S. changes

dramatically during the last two decades. The trend toward equity-based pay appears

to be spreading to the rest of the developed countries. Consequently, the objective of

3

this paper is to provide a long term perspective on the relation between executives’

equity-based compensation and accounting conservatism.

The remainder of this paper is organized as follows: Section 2 discusses related

research and develops the hypothesis. Section 3 describes research design and the

measurement of executives’ equity-based compensation, accounting conservatism,

and variables used. Section 4 outlines the sample selection criteria and reports

descriptive statistics for the variables used. Section 5 presents the empirical results of

accounting conservatism. Section 6 discusses sensitivity analysis. Section 7 draws

conclusion.

4

2. Related Research and Hypothesis Development

Separation of corporate’s ownership and corporate’s control at the turn of the

twentieth century gives rise to the agency problems between managers and

shareholders (Berle and Means 1991). Executives first take into consideration their

own goals and personal reputation instead of firm profits. Managers have incentives

to transfer wealth to themselves from shareholders due to limited horizons and limited

liability. Conflicts of interest between managers and other parties to the firm arise

because information asymmetry, managers have more information than the

stakeholders and effectively control firms’ assets but generally do not have a

significant equity stake in their firms. Thus, one solution to the agency problem is

linking management compensation and shareholders’ equity. During the last two

decades, equity-based pay has increasingly become part of the compensation

packages. Following Murphy (1999) specification, executives’ pay packages contain a

base salary, an annual bonus, stock options, and restricted stock. Equity-based

compensation in this paper contains stock options and restricted stock:

Stock Options give employees the option of buying company stock at a

pre-specified time with the set price that the stock options program grants. Options

give executives a greater incentive to act in the interests of shareholders by providing

a link between realized compensation and company stock price performance. They

5

have no value at the time of issue. If the stock price of the corporation rises, stock

options holders can make a profit by buying the stock below the fair market price.

However, if the company stock price sinks below the option set price, they are

essentially worthless to the employee.

There are always some restrictions apply to the stock options. Like employees

can’t leave the firm before vesting, thus also providing retention incentives. Finally,

stock options encourage executives risk taking, which can mitigate problems with

risk-averse executives.

Restricted Stock is granted to employees in a process known as vesting rather

than buying by employees. Shares earned build up until they reach the vesting period.

Restricted stock help increase employee loyalty and encourage employees to stay with

the company long enough to reach the vesting.

The purpose of equity-based compensation mentioned above serves to increase

employee motivation, improve employee loyalty, and reduce turnover in the

workforce. There is also a considerable amount of empirical evidence that suggest

equity holdings motivate executives to raise profitability and increase shareholder

value. Establishment of an incentive compensation system serves to more closely

identify the manager’s interests with those of the outside equity holders. (Jensen and

Meckling 1976). Effective managers’ compensation structure plays a significant role

6

in protecting shareholders’ wealth. Well-designed equity plans better align top

executives’ interests with shareholders. It strengthens the link between executives’

pay and corporate performance and motivates sustainable, or long-run, value creation

(Hall 2003). Nagar et al. (2003) find that managers with more equity-based

compensation have incentives to mitigate the managerial disclosure agency problem

since their interests are more aligned with shareholders’. Armstrong et al. (2010)

provide evidence that executives with greater equity incentives may lower frequency

of accounting irregularities and reduce improper financial reporting. In sum, those

researches are consistent with the notion that equity-based compensation for

executives plays a role in mitigating the agency problem between managers and

shareholders.

Watts (2003) demonstrates that conservatism can be another method of reducing

the information asymmetry between managers and shareholders. Without a

verification requirement, executives can overstate future cash flows; maximize their

payments under earning-based compensation plans; and possibly lead to negative net

present value investments by the firm. LaFond and Watts (2008) imply that

information asymmetry generates demands for conservatism. Conservatism can

reduce information asymmetry by restricting the manager’s ability to manipulate

financial reporting through disclosing negative information faster in form of earnings.

7

As mentioned above, accounting conservatism and equity-based compensation

may both help in aligning the interests of managers and shareholders. Therefore, I

want to evaluate the influence of equity-based compensation to accounting

conservatism policy. Whether the amount or proportion of equity-based compensation

given to executives influences the level of conservatism?

Hypothesis: There is a negative relation between the proportion of

equity-based compensation to executives and the level of conservatism.

This paper adopts Basu’s model to assess accounting conservatism. Conditional

conservatism is defined as the imposition of stricter verification standards for

recording good news as gains than for recording bad news as losses. Under

unconditional conservatism, the book value of net assets is understated because of

predetermined aspects of the accounting process(Beaver and Ryan 2005). Ball and

Shivakumar (2005) state that “an unconditional bias of unknown magnitude

introduces randomness in decisions based on financial information and can only reduce contracting efficiency. In contrast, the conditional form of conservatism can

improve contracting efficiency. The agency issues associated with unconditional

conservatism are likely to disorder its’ relation with executives’ equity-based

compensation. ” Consequently, the test of hypothesis is restricted to the association

between equity-based compensation and conditional conservatism.

8

3. Research Design

3.1. The measure of executives’ compensation

The sample of executives’ compensation is based on Standard & Poor's

Execucomp database during the period 1993-2012. In 1992, the Securities and

Exchange Commission (SEC) began asking firms to disclose more detailed

information on executives’ compensation in their proxy statements. Reporting rules

on executive compensation do change over time, the FAS123(R) changed the

reporting requirements of the SEC DEF14A form in 2005. Companies with fiscal year

end after Dec 2005 have to adjust to new reporting requirement. Equity-based

compensation has to be expensed and be reflected in the financial statements based on

fair value of the awards. Prior to 2006, the variables called

“OPTION_AWARDS_BLK_VALUE” and “RSTKGRNT” are used to represent

executives’ equity-based compensation. The “OPTION_AWARDS_FV” and

“STOCK_AWARDS_FV” columns are essentially comparable between the old and

new reporting formats after 2006.

3.2. The measure of accounting conservatism

I adopt Basu’s model to measure accounting conservatism. Under conservative

accounting, earnings capture bad news faster than good news because of the

asymmetric standards of verification of losses and gains.

9

EPSBPt

= β

+ β

R + β

D + β

R*D +ε

where

EPSBPt

the price per share at the beginning of the fiscal year (Pit-1).

R is the stock rate of return of the firm, measured by compounding 12 monthly

CRSP stock returns ending the last day of fiscal year t.

D is a dummy variable=1 if R < 0, = 0 otherwise.

The coefficient β3 measures the level of asymmetric timeliness of conservatism

and it is expected to be positive and significant

3.3. Empirical model

In order to test hypothesis, I use the following model to investigate the relation

between executives’ equity-based compensation and accounting conservatism:

EPSBPt

= β

+ β

R + β

D + β

R*D + ECOMP*(β

+ β

R + β

D + β

R*D) +

Size*(β

+ β

R + β

D + β

R* D) + Leverage*(β

+ β

R + β

D + β

R*D)

+ Growth*(β

+ β

R + β

D + β

R*D) +ε

10

where

ECOMP is the ratio of top five executives’ equity-based compensation,

including stock options and restricted stock, to top five executives’ total compensation

in fiscal year t. Total compensation for the individual year, comprised of the following:

salary, bonus, other annual, total value of restricted stock granted, total value of stock

options granted, long-term incentive payouts, and all other total. Valuation is based on

the grant date fair value reported by company or using standard and poor’s

Black-Scholes methodology before 2006.

Leverage is total debts divided by total assets at the beginning of the fiscal year t.

It’s a variable to control conservatism demands of debt holders. Ahmed et al. (2002)

find accounting conservatism mitigates conflicts between bondholders and

shareholders over dividend policy. Conservatism benefits lenders through a timely

signal of default risk.

Growth is the ratio of market value of equity to book value of equity at the

beginning of the fiscal year ^t to control for the effect of beginning composition of

equity value on future asymmetric timeliness.The Basu’s measure is affected by the

beginning composition of equity value. Asymmetric timeliness appears to measure

conservatism more efficiently when estimated cumulatively over several periods.

(Roychowdhury and Watts, 2007)

11

Size is natural log of total assets at the beginning of the fiscal year t. The firm's

degree of reporting conservatism is affected by firm size. Firm size influencing

conservatism is information asymmetries. It is positively correlated with the relative

amount of public information which reduces information asymmetry between

investors (Givoly et al., 2007; LaFond and Watts, 2008).

The Appendix A of this paper provides more detailed definition and items of

variables from each database.

The coefficient of ECOMP*R*D (β7) measures the relation between executives’

equity-based compensation and accounting conservatism with regard to bad news. If it

is consistent with the prediction of hypothesis, β7 would be negative.

12

4. Sample Selection and Descriptive Statistics

The sample of executives’ compensation is obtained from S&P ExecuComp

database over the period 1993 to 2012. In addition to requiring compensation data, I

require firms’ accounting data on Compustat and returns data on CRSP to conduct my

empirical analyses. Table1 Panel A summarizes my sample selection procedure. I

obtain the initial sample of 37,603 observations on ExecuComp database for

1993-2012. Next, I merge Compustat and ExecuComp, excluding companies without

complete accounting data or executives’ compensation information, and remains in

37,569 observations. Afterward, I combine returns data on CRSP with Compustat and

ExecuComp, which result in a sample of 23,328 observations. Finally, after deleting

outliers of each variable at 0.5% level to improve the quality of regression, the sample

is reduced to 22,302 observations. Panel B reports sample classification by fiscal year

and by industry which determined by NAICS (North America Industry Classification

System) code. It informs that there are sufficient data in each year, and the firms range

over Manufacturing, Finance and Insurance and so on.

13 Table 1

Panel A: Sample selection

Compustat, ExecuComp and CRSP data over 1993-2012.

Number of Firms

Firms’ executives’ compensation on ExecuComp 37,603

Less companies without complete accounting data or executives’

compensation information (34)

Merge Compustat and ExecuComp 37,569

(14,241)

Combine CRSP with Compustat and ExecuComp 23,328

Delete outliers of each variable (1,026)

Final number of observations 22,302

Panel B: Samples classified by fiscal year and by industry

Fiscal Year N Industry N

1993 1,278 11 Agriculture, Forestry, Fishing and Hunting 51 1994 1,381 21 Mining, Quarrying, and Oil and Gas Extraction 1,045

1995 1,367 22 Utilities 1,529

1996 1,395 23 Construction 355

1997 1,334 31-33 Manufacturing 10,008

1998 1,302 42 Wholesale Trade 711

1999 1,206 44-45 Retail Trade 1,413

2000 1,096 48-49 Transportation and Warehousing 659

2001 1,055 51 Information 1,254

2002 1,068 52 Finance and Insurance 2,842

2003 1,085 53 Real Estate and Rental and Leasing 400

2004 1,073 54 Professional, Scientific, and Technical Services 584 2005 1,033 56 Administrative and Support and Waste Management

and Remediation Services

309

2006 979 61 Educational Services 72

2007 998 62 Health Care and Social Assistance 295

2008 956 71 Arts, Entertainment, and Recreation 68

2009 934 72 Accommodation and Food Services 537

2010 949 81 Other Services (except Public Administration) 103

2011 929 99 Nonclassifiable Establishments 67

2012 884

Total 22,302 Total 22,302

14

Table2 reports the descriptive statistics for the variables used in this study. The

descriptive statistics in Table2 indicates the mean of fiscal stock returns is 0.146100,

which is generally consistent with those of previous studies. The mean and median of

logT5EBC and ECOMP are 6.068635, 6.378178 and 0.381032, 0.386873,

respectively.

The Appendix B of this paper provides descriptive statistics for stock options

(using “OPTION_AWARDS_BLK_VALUE” and “OPTION_AWARDS_FV”),

restricted stock (using “RSTKGRNT” and “STOCK_AWARDS_FV”), logT5EBC,

and ECOMP each year.

Table 2 Descriptive Statistics

The sample consists of 22,302 firms. Variables are averaged over 1993-2012.

Variable Median Mean Std. Dev. P10 P25 P75 P90

EPSBPt1 0.052345 0.034458 0.105392 -0.033571 0.024812 0.075790 0.103066 R 0.101258 0.146100 0.438269 -0.33228 -0.116646 0.334380 0.636365

D 0 0.372702 0.483535 0 0 1 1

logT5EBC 6.378178 6.068635 1.205129 3 5.842007 6.817565 7.155828 ECOMP 0.386873 0.381032 0.239362 0 0.193833 0.564376 0.69871 Leverage 0.210086 0.220999 0.167732 0.001595 0.076793 0.333523 0.438545 Growth 2.084703 2.784916 2.462708 1.019236 1.426739 3.261614 5.220283 Size 9.208204 9.261585 0.761314 8.313515 8.692178 9.777021 10.31664

15

Table3 reports the correlation matrix among the variables. It shows that although

EPSBPt1 is positively correlated with R (0.2141), it is negatively correlated with D

(-0.2247). Those are consistent with Basu’s results, indicating that reported earnings

reflect at least a portion of the information reflected in returns.

Table 3 Correlation Table

The sample consists of 22,302 firms. Variables are averaged over 1993-2012.

EPSBPt1 R D logT5EBC ECOMP Leverage Growth Size

EPSBPt1 1.0000

R 0.2141 1.0000

D -0.2247 -0.6704 1.0000

logT5EBC 0.0101 0.0101 -0.0139 1.0000

ECOMP -0.0601 -0.0240 0.0521 0.8045 1.0000

Leverage -0.0352 -0.0096 -0.0149 0.0330 -0.0243 1.0000

Growth 0.0408 -0.0482 0.0557 0.1257 0.2025 -0.0803 1.0000

Size 0.1108 -0.0641 -0.0525 0.3376 0.1821 0.2608 -0.0754 1.0000

16

5. Empirical Results

Table4 tests conservatism using Basu’s regression. Under the definition, the

coefficient of R measures the timeliness of earnings with respect to good news. In

contrast, the coefficient of R*D measures the “incremental” timeliness of earnings

regarding bad news. Therefore, β3 is predicted to be positive and significant. In this

analysis I focus on the coefficient of R*D because it measures the degree of

accounting conservatism.

The result is consistent with Basu’s model under conservatism. β3 is positive

(0.6342652) and significant, which means that earnings reflect “bad news” more

quickly than “good news”. Besides, the intercepts is positive (0.0335077) which

implies that unrealized gains is postponed to future periods.

Table 4

Test of Basu’s Model: Fiscal Year Returns

Model: EPSBPt1 = β0 + β1R + β2D + β3R*D

* p<.1, ** p<0.05, *** p<0.01

β0 β1 β2 β3

0.0335077***

(3.30)

0.0176202 (1.33)

0.0821693***

(4.08)

0.6342652***

(11.32)

17

Table5 tests the relation between proportion of equity-based compensation and

accounting conservatism:

EPSBPt

= β

+ β

R + β

D + β

R*D +ECOMP*(β

+ β

R + β

D + β

R*D ) +

Size*(β

+ β

R + β

D + β

R*D ) + Leverage*(β

+ β

R + β

D + β

R*D )

+ Growth* (β

+ β

R + β

D + β

R*D ) +ε

In the regression, β1 measures earnings timeliness with respect to good news and β3 measures the asymmetric timeliness with respect to bad news. β5, β9, β13, and β17

measure the association of β1 with ECOMP, Leverage, Growth, and Size, respectively.

β7, β11, β15, and β19 measure the association of β3 with ECOMP, Leverage, Growth,

and Size, respectively. The coefficient of ECOMP*R*D (β7), measuring the relation

between proportion of executives’ equity-based compensation and accounting

conservatism with regard to bad news, is predicted to be negative.

Within the sample period 1993-2012, Table5 represents that coefficient on R*D

is significantly positive (0.425), and the coefficient on ECOMP*R*D is significantly

negative (-0.0525). These results suggest that as ratio of executives’ equity-based

compensation to total compensation declines, earnings become more asymmetrically

timely in recognizing bad news.

18

Turning to control variables, they are in accordance with the theoretical

prediction. The coefficient of Leverage*R*D is positive and significant as expected,

indicating that firms with greater leverage are more asymmetrically timely in

recognizing bad news. The coefficient of Growth*R*D and Size*R*D are both

significantly negative which is consistent with extant empirical evidence. There is

relatively more public information for larger firms (Banz 1981). Firm size is

positively correlated with the relative amount of public information which reduces

information asymmetry between investors generating a negative association with

conservatism.

19 Table 5

Test of Hypothesis: There is a negative relation between the proportion of equity-based compensation to executives and the level of conservatism.

Model: EPSBPt1 = β0 + β1R + β2D + β3R*D + ECOMP*(β4 + β5R + β6D + β7R*D ) + Size*(β8 + β9R + β10D + β11R*D ) + Leverage*(β12 + β13R + β14D + β15R*D ) + Growth*(β16 + β17R + β18D + β19R*D )

t statistics in parentheses

* p<.1, ** p<0.05, *** p<0.01, p-values are one-tailed when the sign of the coefficient is predicted, two-tailed otherwise.

Independent Variables Predict Sign 1993-2012

R + -0.0211

(-0.79)

D -0.0138

(-0.53)

R*D + 0.425***

(5.45)

ECOMP -0.0314***

(-6.20)

ECOMP*R -0.0206**

(-2.35)

ECOMP*D -0.00973

(-1.08)

ECOMP*R*D - -0.0525**

(-2.04)

Leverage -0.0130*

(-1.80)

Leverage*R -0.0413***

(-3.24)

Leverage*D 0.0135

(1.05)

Leverage*R*D + 0.271***

(7.39)

Growth 0.000122

(0.25)

Growth*R -0.000203

20

To provide more specific relation between equity-based compensation and

accounting conservatism, I divide the whole sample period into four parts: 1993-2001,

2003-2005, 2006-2008, and 2009-2012 owing to following reasons:

There has been a dramatic change in both the level and composition of executive

pay in the U.S. during the last two decades. The level of compensation has increased

substantially in 1990s, and the increase was attributed to the grant of stock options.

During the early 1990s, stock options became a single largest component of

compensation (Murphy 1999). I set the first period from 1993-2001 due to a small

decrease in stock options granted to executives since 2002. Corporate accounting

scandals including those at Enron, WorldCom and other companies, have been linked

(-0.26)

Growth*D -0.0000928

(-0.11)

Growth*R*D - -0.0297***

(-12.84)

Size 0.0134***

(8.41)

Size*R 0.00505*

(1.66)

Size*D 0.00259

(0.89)

Size*R*D - -0.0165**

(-1.87)

_cons -0.0602***

(-4.19)

N 22,302

Adj R-squared 0.1553

21

to escalation in option grants. Stock options have been criticized on giving managers a

strong incentive to risk chasing investments and misleading shareholders about the

true condition of their companies (MaDick 2003). To avoid bias analysis, it is

necessary to exclude year 2002 from the sample.

Next period is 2003-2005. As of fiscal year 2006, executive compensation is

reported under new filling requirements. Companies with fiscal year end after Dec

2005 have to adjust to new reporting requirement FAS123(R). This statement focuses

primarily on accounting for share-based payment transactions exchanging employee

services. Equity-based compensation has to be expensed and be reflected in the

financial statements based on fair value of the awards. Prior to FASB 123(R),

companies could expense options using the intrinsic value method and often recorded

no associated expense on their Income Statement. Before 2006 the variable collected

from Execucomp called “OPTION_AWARDS_BLK_VALUE” and “RSTKGRNT”

are used. The OPTION_AWARDS_FV and STOCK_AWARDS_FV columns are

essentially comparable between the old and new reporting formats after 2006. They

both represent the value of options/restricted stock that were awarded during the

indicated fiscal year. The one difference is that under the old format, the Black

Scholes values for options were calculated by S&P (since companies were not

required to report them); under the new format, Black Scholes values are reported by

22

the company. Hall and Murphy (2002) suggest that models of firms’ choices of equity

compensation methods should include the accounting considerations. Carter et al.

(2007) support the assertion that accounting affects the design of executive

compensation. On the basis of previous studies, year 2006 might be a watershed for

executives’ structure of compensation.

The third and fourth periods are 2006-2008 and 2009-2012. Subprime mortgage

crisis in 2007 and the collapse of Lehman Brothers and problems of Merrill Lynch,

AIG, Freddie Mac, Fannie Mae… in late 2008 almost brought down the world’s

financial system. The financial crisis is considered by many economists the worst

financial crisis since the Great Depression of the 1930s, which might affect the

analysis results. Therefore, I divide the year after 2006 into those two parts.

Appendix C reports the descriptive statistics for the variables used in this study

of different periods.

23 Table 6

Test of Hypothesis: There is a negative relation between the proportion of equity-based compensation to executives and the level of conservatism.

Model: EPSBPt1 = β0 + β1R + β2D + β3R*D + ECOMP*(β4 + β5R + β6D + β7R*D ) + Size*(β8 + β9R + β10D + β11R*D ) + Leverage*(β12 + β13R + β14D + β15R*D ) + Growth*(β16 + β17R + β18D + β19R*D )

t statistics in parentheses

* p<.1, ** p<0.05, *** p<0.01, p-values are one-tailed when the sign of the coefficient is predicted, two-tailed otherwise.

Independent Variables

Predict Sign

1993-2001 2003-2005 2006-2008 2009-2012

R + -0.0615** -0.0916* -0.106 0.0762

(-1.94) (-1.29) (-0.76) (0.96)

D -0.00698 0.152* -0.0811 0.0465

(-0.20) (1.88) (-0.98) (0.62)

R*D + 0.718*** 1.605*** 0.327* 0.929***

(6.59) (4.65) (1.47) (3.59)

ECOMP -0.0314*** -0.0336*** -0.0285 -0.0203

(-4.99) (-2.60) (-1.60) (-1.36)

ECOMP*R -0.0369*** 0.0438** 0.0262 -0.0452

(-3.66) (1.97) (0.58) (-1.57)

ECOMP*D -0.0233** 0.00706 -0.00877 0.0214

(-2.04) (0.25) (-0.33) (0.76)

ECOMP*R*D - -0.0295 -0.224** -0.120** -0.0249

(-0.88) (-2.12) (-1.66) (-0.27)

Leverage -0.00798 -0.00536 -0.0362 -0.0415**

(-0.84) (-0.30) (-1.31) (-2.42)

Leverage*R -0.0142 -0.0968*** 0.0439 -0.0767**

24

(-0.89) (-3.11) (0.57) (-2.51)

Leverage*D 0.0348** 0.0596 0.0502 -0.0122

(2.03) (1.49) (1.31) (-0.35)

Leverage*R*D + 0.366*** 0.765*** 0.118 0.511***

(7.48) (5.23) (1.11) (3.94)

Growth -0.00158** -0.000521 0.00181 0.00307**

(-2.57) (-0.41) (0.99) (2.30)

Growth*R -0.000505 0.00443* -0.00477 0.00567*

(-0.59) (1.91) (-1.01) (1.71)

Growth*D 0.00175 0.00342 -0.00743*** 0.00324

(1.59) (1.21) (-2.84) (1.29)

Growth*R*D - -0.0183*** -0.0377*** -0.0502*** -0.0410***

(-6.38) (-3.74) (-7.21) (-4.49)

Size 0.00823*** 0.0164*** 0.0118** 0.0219***

(3.96) (3.97) (1.96) (5.19)

Size*R 0.0106*** 0.00793 0.0158 -0.00438

(2.91) (0.97) (0.99) (-0.49)

Size*D 0.00103 -0.0190** 0.0138 -0.00613

(0.27) (-2.10) (1.52) (-0.74)

Size*R*D - -0.0619*** -0.136*** 0.00450 -0.0712***

(-4.88) (-3.40) (0.18) (-2.51)

_cons -0.0103 -0.0856** -0.0555 -0.149***

(-0.56) (-2.27) (-1.01) (-3.87)

N 11,414 3,191 2,933 3696

Adj R-squared 0.1475 0.1473 0.2451 0.1648

25

The coefficient of ECOMP*R*D in period 1993-2001 is negative but not

significant. Thanks to Jensen & Murphy (1990) demonstrating that the compensation

of top executives is virtually independent of their performance, peoples’

understanding of the link between CEO compensation and company performance has

improved substantially. They argue that pay-performance sensitivity in managerial

compensation contracts is too low to provide executives with incentives to act in the

interests of shareholders. The most powerful link between shareholder wealth and

executive wealth is direct stock ownership by the CEO. However, CEO holdings as a

percentage of corporate value compare to prior decades have declined. Figure1 shows

that the mean of ECOMP has grown in the 1990s and reached 40% (the sample mean

of ECOMP is 38%) in 1998. Nevertheless, the empirical result is insignificant. I think

the first reason might be that equity-based compensation for US executives has just

become increasing popular in 1990s. Second, companies generally do not treat

options as an expense, either at time of grant or exercise, on company financial

statements at that time. In 1992, SEC’s new disclosure rules, comprising with firms,

would only report “numbers” of option grants. It suggests that shareholders may be

difficult to understand manager’s compensation policy.

26

0.1.2.3.4.5

mean of RMCOMP

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Figure 1 The mean of ECOMP

Period 2003-2005 and 2006-2008 are consistent with my hypothesis that the

coefficient of ECOMP*R*D is significantly negative at 0.05 levels. These results

suggest that the asymmetric timeliness of earnings declines with managerial

proportion of executives’ equity-based compensation. Executives’ equity-based

compensation plays a role in accounting conservatism policy. In 1995, SFAS 123

encourages firms to calculate stock-based compensation expense based on the fair

value of options granted, but permits entities to continue using APB 25. Following the

financial reporting scandals of firms such as Enron and WorldCom, dozens of firms

began to announce their intention to recognize SFAS 123 expense voluntarily. Firms

that are more active in the capital markets are more likely to reap benefits from such a

signal (Aboody et al. 2004). Executives’ compensation structure will change through

the time and accounting considerations. Prior to implementation of FAS123(R), firms

make decisions based on the perceived costs rather than the economic costs, they

27

grant more options than they would. It is important to note that firms appear to

substitute away from stock options towards other forms of performance-based pay as

opposed to salary because of FAS123(R) (Hayes et al 2012). Murphy (2012) also

illustrates that the use of restricted shares gradually substitute for stock options to top

executives. According to Hall and Murphy (2003), incentives are maximized through

granting nontradable restricted stock rather than options, and it also affects managerial

incentives to engage in risky investments. Consequently, the trends can support period

2003-2005 and 2006-2008 are consistent with my hypothesis that the coefficient of

ECOMP*R*D is significantly negative.

The coefficient of ECOMP*R*D in period 2009-2012 is negative but not

significant. Although options accounted for only 20 percent of total pay, while

restricted stock had ballooned to 34 percent by 2010 (Murphy 2012), catastrophic

corporate failure in late 2008 draws shareholders’ attention on options which

incentivize managers’ excessive risk seeking behavior. On the other hand, benefits of

options will backfire in bear market (Hall and Murphy 2003). According to CenFIS

reports, the financial crisis in September and October 2008 was accompanied by

stunning decreases in stock prices. The S&P 500 fell 48 percent in a little over six

months. Executives and employees at many companies hold worthless options in

response to financial crisis. The effects mutually may cause the relation between the

28

proportion of equity-based compensation to executives and the level of conservatism

in significant.

Table7 reports the results which replace ECOMP with logT5EBC to assess my

results and provide additional insights. The findings are similar to those in Table6.

EPSBPt

= β

+ β

R + β

D + β

R*D + logT5EBC* (β

+ β

R + β

D + β

R*D )

+ Size*(β

+ β

R + β

D + β

R*D ) + Leverage*(β

+ β

R + β

D + β

R*D ) + Growth*(β

+ β

R + β

D + β

R*D ) +ε

where

logT5EBC is the log of equity-based compensation, including stock option and

restricted stock grants, to top five executives. Valuation is based on the grant date fair

value reported by company or using standard and poor’s Black-Scholes methodology

before 2006.

29 Table 7

Test of Hypothesis: There is a negative relation between the proportion of equity-based compensation to executives and the level of conservatism.

Model: EPSBPt1 = β0 + β1R + β2D + β3R*D + logT5EBC*(β4 + β5R + β6D + β7R*D ) + Size*(β8 + β9R + β10D + β11R*D ) + Leverage*(β12 + β13R + β14D + β15R*D ) + Growth*(β16 + β17R + β18D + β19R*D )

t statistics in parentheses

* p<.1, ** p<0.05, *** p<0.01, p-values are one-tailed when the sign of the coefficient is predicted, two-tailed otherwise.

Independent Variables

Predict Sign

1993-2001 2003-2005 2006-2008 2009-2012

R + -0.0599** -0.104* -0.116 0.0795

(-1.84) (-1.44) (-0.83) (1.00)

D -0.0110 0.153* -0.0758 0.0394

(-0.32) (1.88) (-0.93) (0.53)

R*D + 0.666*** 1.725*** 0.369** 1.033***

(6.19) (5.08) (1.68) (4.01)

logT5EBC -0.00326** -0.00173 -0.000297 -0.000236

(-2.48) (-0.64) (-0.10) (-0.08)

logT5EBC*R -0.00564** 0.00998** -0.00216 -0.00582

(-2.42) (1.98) (-0.28) (-1.02)

logT5EBC*D -0.00194 -0.00726 -0.00673 0.00748

(-0.83) (-1.20) (-1.49) (1.34)

logT5EBC*R*D - 0.00868 -0.0680*** -0.0358*** -0.00291

(1.18) (-2.99) (-2.66) (-0.18)

Leverage -0.00684 -0.00425 -0.0373 -0.0437**

(-0.72) (-0.24) (-1.35) (-2.55)

Leverage*R -0.0124 -0.0915*** 0.0406 -0.0721**

30

(-0.78) (-2.98) (0.53) (-2.36)

Leverage*D 0.0303* 0.0586 0.0519 -0.0115

(1.77) (1.48) (1.35) (-0.33)

Leverage*R*D + 0.345*** 0.748*** 0.115 0.520***

(7.13) (5.15) (1.08) (3.99)

Growth -0.00205*** -0.00103 0.00160 0.00317**

(-3.35) (-0.82) (0.87) (2.39)

Growth*R -0.000886 0.00451** -0.00473 0.00431

(-1.04) (1.96) (-1.00) (1.33)

Growth*D 0.00153 0.00434 -0.00735*** 0.00291

(1.41) (1.54) (-2.81) (1.16)

Growth*R*D - -0.0193*** -0.0346*** -0.0490*** -0.0402***

(-7.05) (-3.42) (-7.03) (-4.55)

Size 0.00836*** 0.0157*** 0.00951 0.0194***

(3.85) (3.64) (1.55) (4.44)

Size*R 0.0124*** 0.00401 0.0194 -0.00242

(3.28) (0.48) (1.20) (-0.26)

Size*D 0.00190 -0.0144 0.0173* -0.00946

(0.48) (-1.52) (1.85) (-1.10)

Size*R*D - -0.0613*** -0.115*** 0.0187 -0.0825***

(-4.80) (-2.78) (0.73) (-2.92)

_cons -0.00107 -0.0794** -0.0416 -0.132***

(-0.06) (-2.10) (-0.77) (-3.50)

N 11,470 3,204 2,923 3,692

Adj R-squared 0.1390 0.1470 0.2468 0.1639

31

6. Sensitivity Analysis

6.1. The effect of the investment opportunity set (IOS)

Smith and Watts (1992) find that firms’ investment opportunity set (IOS), the

extent to which firm value is determined by growth options and intangible assets, is

related to their financing, dividend, and executive compensation policies. Skinner

(1993) also mentions that the structure of management compensation agreements will

vary across firms as a function of the IOS. Managers of firms with relatively more

growth opportunities are likely to be allowed more decision making discretion

because these managers have better information about the firm’s investment

opportunities than shareholders. Smith and Watts predict that growth firms are more

likely to use incentive compensation plan that tie management compensation to

measures of firm performance.

Roychowdhury and Watts (2007) provide insights into the link between the IOS

and accounting conservatism. US GAAP prohibits upward revaluations of assets,

changes in the value of growth options, and capitalization of certain internally

generated intangibles. Consequently, subsequent declines in the value of these

unrecorded assets are also not recognized. Earnings of firms with high growth options

are not very informative, in other words, low observed conservatism when changes in

firm value are driven by changes in the value of growth options and intangible assets.

32

In summary, the IOS has a positive association with managers’ equity-based

compensation and negative association with accounting conservatism. Thus, it is

possible that variation in the IOS induces a negative relation between executives’

equity-based compensation and accounting conservatism. I try to control the effect of

IOS. As investment opportunities are typically unobservable by outsiders, a common

practice is to rely on proxy variables. According to Adam and Goyal (2008),

market-to-book assets ratio (MBA ratio) has the highest information content with

respect to investment opportunities.

EPSBPt

= β

+ β

R + β

D + β

R*D + ECOMP*(β

+ β

R + β

D + β

R*D ) +

Size*(β

+ β

R + β

D + β

R*D ) + Leverage*(β

+ β

R + β

D + β

R*D )

+ Growth*(β

+ β

R + β

D + β

R*D ) + MBA*(β

+ β

R + β

D + β

R*D) + ε

where

MBA ratio is (share price × shares outstanding + preferred stock + debt in

current liabilities + long-term debt – deferred taxes and investment tax credit) /book

value of assets.

The results are robust after controlling for the investment opportunity set.

33 Table 8

Sensitivity Analysis (IOS)

Model: EPSBPt1 = β0 + β1R + β2D + β3R*D + ECOMP*(β4 + β5R + β6D + β7R*D ) + Size*(β8 + β9R + β10D + β11R*D ) + Leverage*(β12 + β13R + β14D + β15R*D ) + Growth*(β16 + β17R + β18D + β19R*D ) + MBA*(β16 + β17R + β18D + β19R*D )

t statistics in parentheses

* p<.1, ** p<0.05, *** p<0.01, p-values are one-tailed when the sign of the coefficient is predicted, two-tailed otherwise.

Independent Variables

Predict Sign

1993-2001 2003-2005 2006-2008 2009-2012

R + -0.0549** -0.139** -0.120 0.0321

(-1.67) (-1.90) (-0.81) (0.37)

D -0.00750 0.127 -0.1000 -0.0247

(-0.20) (1.50) (-1.11) (-0.30)

R*D + 0.805*** 1.758*** 0.543** 0.692***

(6.87) (4.98) (2.28) (2.49)

ECOMP -0.0309*** -0.0299** -0.0255 -0.0192

(-4.83) (-2.28) (-1.41) (-1.26)

ECOMP*R -0.0329*** 0.0335 0.0242 -0.0496*

(-3.17) (1.49) (0.53) (-1.71)

ECOMP*D -0.0225* -0.0000535 -0.0115 0.0133

(-1.94) (-0.00) (-0.43) (0.47)

ECOMP*R*D - -0.0246 -0.184** -0.103* -0.0548

(-0.73) (-1.71) (-1.42) (-0.59)

Leverage -0.00908 -0.0145 -0.0443 -0.0410**

(-0.93) (-0.78) (-1.56) (-2.37)

Leverage*R -0.0221 -0.0740** 0.0459 -0.0778**

(-1.33) (-2.31) (0.58) (-2.54)

34

Leverage*D 0.0318* 0.0752* 0.0554 -0.00382

(1.82) (1.78) (1.41) (-0.11)

Leverage*R*D + 0.342*** 0.671*** 0.0630 0.554***

(6.71) (4.37) (0.58) (4.25)

Growth -0.000304 0.00171 0.00385 0.00401**

(-0.31) (0.95) (1.51) (2.22)

Growth*R 0.000479 -0.000758 -0.00547 0.000475

(0.37) (-0.26) (-0.90) (0.10)

Growth*D 0.00185 0.00173 -0.00877** -0.00397

(0.97) (0.40) (-2.43) (-1.11)

Growth*R*D - -0.0100** -0.0125 -0.0338*** -0.0732***

(-1.92) (-0.75) (-3.59) (-4.23)

Size 0.00689*** 0.0150*** 0.00954 0.0212***

(3.12) (3.46) (1.52) (4.72)

Size*R 0.0101*** 0.0113 0.0171 -0.000108

(2.69) (1.37) (1.05) (-0.01)

Size*D 0.00105 -0.0174* 0.0154 0.000615

(0.25) (-1.87) (1.60) (0.07)

Size*R*D - -0.0707*** -0.148*** -0.0144 -0.04768*

(-5.27) (-3.65) (-0.56) (-1.58)

MBA -0.00310 -0.00904** -0.00649 -0.00244

(-1.58) (-2.02) (-1.06) (-0.49)

MBA*R -0.00255 0.0240*** 0.00260 0.0156

(-0.99) (2.85) (0.17) (1.41)

MBA*D 0.000427 0.00994 0.00463 0.0208**

35

6.2. Returns in the two ends of the bell curve

In addition, in robustness check, I use the sample which their economic

losses/gains located in less than 25 percentages (Q1) or more than 75 percentages (Q4)

to test whether the relation between executives’ equity-based compensation and

conservatism are more sensitive. I predict that accounting conservatism can be more

observable when firms whose returns situated in the two ends of the bell curve are

included in the same period. Table9 Panel A expresses return’s quartile of four

periods. In period 2003-2005, I choose the firms whose returns are less than

0.0111017 or more than 0.3983957. In period 2006-2008, firms whose returns are less

than -0.2743965 or more than 0.1802682 are selected. Panel B uses the same

regression to test the hypothesis. I find that the result of period 2006-2008 is more

significant.

(0.12) (1.03) (0.55) (2.40)

MBA*R*D - -0.0165** -0.0754** -0.0566*** 0.0692**

(-1.78) (-2.12) (-2.49) (2.14)

_cons 0.00304 -0.0666 -0.0298 -0.142***

(0.15) (-1.64) (-0.51) (-3.38)

N 11,414 3,191 2,933 3,696

Adj R-squared 0.1486 0.1502 0.2505 0.1663

36 Table 9

Panel A: Return’s quartile

Period N mean sd P25 P50 P75

1993-2001 11,414 0.1710168 0.4632303 -0.1144058 0.109894 0.3714427 2003-2005 3,191 0.2484091 0.4157082 0.0111017 0.1916268 0.3983957 2006-2008 2,933 -0.033205 0.3636098 -0.2743965 -0.0445148 0.1802682 2009-2012 3,696 0.1908009 0.3992147 -0.0315893 0.1449931 0.3420506

Panel B: Sensitivity analysis (returns in the two ends of bell curve)

Model: EPSBPt1 = β0 + β1R + β2D + β3R*D + ECOMP*(β4 + β5R + β6D + β7R*D ) + Size*(β8 + β9R + β10D + β11R*D ) + Leverage*(β12 + β13R + β14D + β15R*D ) + Growth*(β16 + β17R + β18D + β19R*D )

t statistics in parentheses * p<.1, ** p<0.05, *** p<0.01, p-values are one-tailed when the sign of the coefficient is predicted, two-tailed otherwise.

Independent Variables

Predict Sign 1993-2001 2003-2005 2006-2008 2009-2012

R + -0.0490 -0.0138 0.0414 0.0717

(-0.87) (-0.11) (0.20) (0.48)

D -0.00792 0.177 0.0542 0.0616

(-0.11) (1.24) (0.23) (0.42)

R*D + 0.676*** 1.528*** 0.262 1.082***

(3.70) (3.48) (0.56) (3.03)

ECOMP -0.0208 -0.0272 -0.0216 -0.00368

(-1.30) (-0.80) (-0.62) (-0.09)

ECOMP*R -0.0446** 0.0382 0.00508 -0.0655

(-2.55) (1.00) (0.07) (-1.31)

ECOMP*D -0.0471* 0.000659 -0.222*** 0.00364

(-1.92) (0.01) (-2.76) (0.07)

ECOMP*R*D - -0.0631 -0.218* -0.517*** -0.00495

(-1.15) (-1.63) (-3.22) (-0.04)

Leverage 0.0197 0.0160 0.0474 -0.0776*

(0.80) (0.32) (0.79) (-1.71)

37

Leverage*R -0.0416 -0.105* -0.107 -0.0392

(-1.50) (-1.90) (-0.84) (-0.74)

Leverage*D 0.0327 0.0382 -0.0253 0.0407

(0.89) (0.57) (-0.23) (0.64)

Leverage*R*D + 0.446*** 0.773*** 0.261 0.526***

(5.58) (4.16) (1.18) (2.97)

Growth -0.00332** 0.0000143 -0.00237 0.00290

(-2.32) (0.00) (-0.74) (0.69)

Growth*R 0.00105 0.00361 0.00223 0.00566

(0.74) (0.83) (0.34) (0.89)

Growth*D 0.00257 0.00288 -0.0190*** 0.00251

(1.21) (0.55) (-2.64) (0.50)

Growth*R*D - -0.0222*** -0.0368*** -0.0857*** -0.0435***

(-5.08) (-2.85) (-5.95) (-3.51)

Size 0.00763 0.0200 0.0187 0.0186

(1.43) (1.60) (1.63) (1.44)

Size*R 0.00891 -0.00197 0.000982 -0.00475

(1.35) (-0.13) (0.04) (-0.28)

Size*D 0.00304 -0.0227 0.0237 -0.00827

(0.35) (-1.41) (0.90) (-0.50)

Size*R*D - -0.0507** -0.126*** 0.0577 -0.0862**

(-2.35) (-2.47) (1.08) (-2.19)

_cons -0.00342 -0.110 -0.125 -0.110

(-0.07) (-0.99) (-1.21) (-0.95)

N 5,708 1,596 1,468 1,848

Adj R-squared 0.1720 0.1533 0.3205 0.1832

38

6.3. Results excluding NAICS 22&52, First 6 NAICS without 22&52

Political pressures may constrain top executive pay levels in utilities and finance

industry. Therefore, Table10 tries to examine the results after excluding NAICS 22

Utilities and 52 Finance and Insurance. Furthermore, it provides the results are robust

of the first 6 biggest NAICS without utilities and finance.

Further, the empirical result is a monotonic function after using ECOMP² to test.

6.4. Results of stock options

According to Lafond and Roychowdhury (2008), their measures of managerial

ownership exclude shares granted in options. They consider shares granted in options

have potentially different incentive effects than shares owned. Therefore, I try to

examine the results of stock options of my analysis. In Table11, the results are robust

after undertaking a similar analysis as in Table 6 but use S as an explanatory variable.

EPSBPt

= β

+ β

R + β

D + β

R*D + S*(β

+ β

R + β

D + β

R*D ) +

Size*(β

+ β

R + β

D + β

R*D ) + Leverage*(β

+ β

R + β

D + β

R*D )

+ Growth*(β

+ β

R + β

D + β

R*D ) + ε

where

S is the ratio of stock options to top five executives’ total compensation in fiscal

year t.

39 Table 10

Empirical results excluding NAICS 22 & 52,First 6 NAICS without 22 & 52

Model: EPSBPt1 = β0 + β1R + β2D + β3R*D + ECOMP*(β4 + β5R + β6D + β7R*D ) + Size*(β8 + β9R + β10D + β11R*D ) + Leverage*(β12 + β13R + β14D + β15R*D ) + Growth*(β16 + β17R + β18D + β19R*D )

t statistics in parentheses

* p<.1, ** p<0.05, *** p<0.01, p-values are one-tailed when the sign of the coefficient is predicted, two-tailed otherwise.

Independent Variables

Predict Sign

NAICS without 22,52 First 6 NAICS without 22,52 2003-2005 2006-2008 2003-2005 2006-2008

R + -0.0586 -0.193 -0.139* -0.212

(-0.69) (-1.19) (-1.45) (-1.22)

D 0.162 -0.128 0.281** -0.0450

(1.60) (-1.25) (2.57) (-0.41)

R*D + 1.526*** 0.365* 2.284*** 0.714***

(3.75) (1.35) (5.15) (2.47)

ECOMP -0.0296* -0.0200 -0.0397** -0.0103

(-1.85) (-0.92) (-2.23) (-0.44)

ECOMP*R 0.0442* 0.0165 0.0494* 0.00000518

(1.75) (0.32) (1.78) (0.00)

ECOMP*D 0.00410 -0.0159 0.00206 -0.0224

(0.12) (-0.50) (0.06) (-0.64)

ECOMP*R*D - -0.233** -0.108* -0.309*** -0.118*

(-1.95) (-1.29) (-2.35) (-1.31)

Leverage 0.00153 -0.0407 -0.0242 -0.0548

(0.07) (-1.21) (-0.90) (-1.39)

Leverage*R -0.0970*** 0.0424 -0.125*** 0.0434

(-2.66) (0.48) (-3.15) (0.45)

40

Leverage*D 0.0407 0.0388 0.0758 0.0510

(0.85) (0.83) (1.41) (0.92)

Leverage*R*D + 0.763*** 0.0545 0.954*** 0.168

(4.64) (0.43) (5.22) (1.16)

Growth -0.0000367 0.00302 0.0000614 0.00308

(-0.03) (1.44) (0.04) (1.41)

Growth*R 0.00418 -0.00597 0.00320 -0.00668

(1.62) (-1.12) (1.20) (-1.20)

Growth*D 0.00312 -0.00900*** 0.00107 -0.0121***

(0.95) (-3.05) (0.31) (-3.79)

Growth*R*D - -0.0367*** -0.0536*** -0.0442*** -0.0687***

(-3.22) (-6.74) (-3.77) (-7.63)

Size 0.0153*** 0.00478 0.0164*** 0.00586

(2.70) (0.63) (2.61) (0.71)

Size*R 0.00415 0.0268 0.0134 0.0298

(0.42) (1.44) (1.20) (1.49)

Size*D -0.0193* 0.0205* -0.0317** 0.0124

(-1.65) (1.76) (-2.53) (1.00)

Size*R*D - -0.126*** 0.00201 -0.205*** -0.0330

(-2.64) (0.06) (-3.95) (-1.00)

_cons -0.0825* -0.000789 -0.0856 -0.0124

(-1.65) (-0.01) (-1.55) (-0.17)

N 2,574 2362 1,959 1,781

Adj R-squared 0.1387 0.2321 0.1673 0.2678

41 Table 11

Test of Hypothesis: There is a negative relation between the proportion of stock options to executives and the level of conservatism.

Model: EPSBPt1 = β0 + β1R + β2D + β3R*D + S*(β4 + β5R + β6D + β7R*D ) + Size*(β8 + β9R + β10D + β11R*D ) + Leverage*(β12 + β13R + β14D + β15R*D ) + Growth*(β16 + β17R + β18D + β19R*D )

t statistics in parentheses

* p<.1, ** p<0.05, *** p<0.01, p-values are one-tailed when the sign of the coefficient is predicted, two-tailed otherwise.

Independent Variables

Predict Sign

1993-2001 2003-2005 2006-2008 2009-2012

R + -0.0628** -0.0923* -0.103 0.117*

(-2.02) (-1.30) (-0.74) (1.48)

D -0.0143 0.152* -0.0767 0.0402

(-0.42) (1.89) (-0.95) (0.54)

R*D + 0.674*** 1.616*** 0.371** 0.948***

(6.45) (4.74) (1.70) (3.72)

S -0.0358*** -0.0385*** -0.0287 -0.00187

(-5.58) (-2.90) (-1.26) (-0.11)

S*R -0.0281*** 0.0163 -0.0178 -0.109***

(-2.89) (0.76) (-0.30) (-3.21)

S*D -0.0168 -0.00878 -0.0444 -0.0310

(-1.43) (-0.31) (-1.38) (-0.93)

S*R*D - -0.0280 -0.321*** -0.109 -0.0934

(-0.85) (-3.10) (-1.21) (-0.77)

Leverage -0.00968 -0.0106 -0.0427 -0.0419**

(-1.02) (-0.59) (-1.55) (-2.44)

Leverage*R -0.0127 -0.0982*** 0.0429 -0.0814***

42

(-0.81) (-3.16) (0.56) (-2.67)

Leverage*D 0.0337** 0.0603 0.0523 -0.0115

(1.98) (1.50) (1.36) (-0.33)

Leverage*R*D + 0.350*** 0.742*** 0.116 0.513***

(7.23) (5.09) (1.09) (3.98)

Growth -0.00162*** -0.000295 0.00217 0.00283**

(-2.75) (-0.23) (1.17) (2.19)

Growth*R -0.000410 0.00497** -0.00513 0.00672**

(-0.53) (2.16) (-1.09) (2.27)

Growth*D 0.00227** 0.00387 -0.00763*** 0.00361

(2.12) (1.36) (-2.91) (1.46)

Growth*R*D - -0.0159*** -0.0346*** -0.0500*** -0.0417***

(-5.88) (-3.44) (-7.18) (-4.77)

Size 0.00710*** 0.0156*** 0.0102* 0.0204***

(3.46) (3.83) (1.76) (5.15)

Size*R 0.0102*** 0.00934 0.0169 -0.00888

(2.85) (1.16) (1.08) (-1.02)

Size*D 0.00138 -0.0185** 0.0138 -0.00407

(0.36) (-2.09) (1.58) (-0.52)

Size*R*D - -0.0575*** -0.137*** -0.00310 -0.0728***

(-4.75) (-3.51) (-0.13) (-2.66)

_cons 0.0000831 -0.0809** -0.0456 -0.143***

(0.00) (-2.15) (-0.85) (-3.79)

N 11,493 3,199 2,935 3,701

Adj R-squared 0.1459 0.1499 0.2475 0.1671

43

7. Conclusion

Lafond and Roychowdhury (2008) find that conservatism as measured by the

asymmetric timeliness of earnings declines with managerial ownership. They use the

percentage of shares held by the CEO (or the top five highest paid executives) in the

form of direct ownership at the beginning of the fiscal year. But, the coefficient of

shares granted in options separately is insignificant because they consider shares

granted in options have potentially different incentive effects than shares directly

owned. To extend their research, I try to focus on executives’ compensation policy

and value of those stock options and restricted stocks on grant date. First, the CEO of

a large firm with a tiny fractional ownership but an equity stake worth tens of millions

of dollars might worth much than the CEO of a small firm who owns a significant

share of company stocks. Dollar holdings are likely to be the more important

incentive measure in a wide variety of situations (Baker and Hall 1998). Second, I

include the value of share options because I think when the firm grants an incentive

plans to managers will presume they can achieve the goals. Third, executives’

compensation structure will change through the time and accounting considerations.

Changes in accounting standard are associated with adoption or modification of

managers’ incentives plan. I desire to investigate the effect of executives’

compensation policy to firm’s accounting conservatism policy in different periods.