The Impact of Shareholder Litigation Risk on Equity Incentives : Evidence from a Quasi-Natural Experiment

Research output: Journal Publications and Reviews (RGC: 21, 22, 62)21_Publication in refereed journalpeer-review

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Detail(s)

Original languageEnglish
Pages (from-to)427–449
Journal / PublicationThe Accounting Review
Volume96
Issue number6
Online published17 Feb 2021
Publication statusPublished - Nov 2021

Abstract

While prior studies generally support that equity-based compensation induces CEOs to manipulate financial reporting, there is limited direct empirical evidence on whether financial misreporting concerns affect compensation design. A key challenge for establishing a causal relationship is that misreporting incentives and compensation policies are often endogenously determined. Exploiting the exogenous reduction in litigation threat following a 1999 ruling of the U.S. Ninth Circuit Court of Appeals, we examine how heightened misreporting concerns in a less litigious environment affect CEOs' compensation design. Consistent with the theoretical prediction that misreporting concerns prevent companies from providing more powerful incentive pay that is otherwise optimal, we find that firms headquartered in Ninth Circuit states decreased CEOs' equity portfolio vega relative to the control firms after the ruling. We further document that this reduction was concentrated among firms facing greater misreporting concerns post-ruling.

Research Area(s)

  • CEO incentives, equity-based compensation, litigation risk, misreporting, Ninth Circuit Court ruling

Bibliographic Note

Research Unit(s) information for this publication is provided by the author(s) concerned.