RESEARCH ARTICLE
CEO incentive compensation and stock price momentum
Jian Wang,
Yanhuang Huang,
Hongrui Feng,
Xingjian Li,
Shu Yan,
Jian Wang
Department of Finance, School of Business Administration, Northeastern University, Shenyang, China
Search for more papers by this authorYanhuang Huang
Department of Finance, School of Business Administration, Northeastern University, Shenyang, China
Search for more papers by this authorCorresponding Author
Hongrui Feng
Department of Finance, Black School of Business, Penn State Behrend, Erie, Pennsylvania, USA
Correspondence
Hongrui Feng, Department of Finance, Black School of Business, Penn State Behrend, Erie, PA 16563, USA.
Email: [email protected]
Search for more papers by this authorXingjian Li
Department of Finance, School of Economics, Zhejiang University, Hangzhou, China
Search for more papers by this authorShu Yan
Department of Finance, Spears School of Business, Oklahoma State University, Stillwater, Oklahoma, USA
Search for more papers by this authorJian Wang,
Yanhuang Huang,
Hongrui Feng,
Xingjian Li,
Shu Yan,
Jian Wang
Department of Finance, School of Business Administration, Northeastern University, Shenyang, China
Search for more papers by this authorYanhuang Huang
Department of Finance, School of Business Administration, Northeastern University, Shenyang, China
Search for more papers by this authorCorresponding Author
Hongrui Feng
Department of Finance, Black School of Business, Penn State Behrend, Erie, Pennsylvania, USA
Correspondence
Hongrui Feng, Department of Finance, Black School of Business, Penn State Behrend, Erie, PA 16563, USA.
Email: [email protected]
Search for more papers by this authorXingjian Li
Department of Finance, School of Economics, Zhejiang University, Hangzhou, China
Search for more papers by this authorShu Yan
Department of Finance, Spears School of Business, Oklahoma State University, Stillwater, Oklahoma, USA
Search for more papers by this authorFirst published: 19 December 2022
Abstract
We document strong evidence that CEO incentive compensation can predict the significance of stock price momentum through discretionary accrual and real activities manipulation. The profit of momentum strategy increases with CEO pay-for-performance incentive, but decreases with CEO risk-taking incentive. It also evaluates the effects of information uncertainty on such relationship. The evidence is more significant for firms with older and longer tenured CEOs and firms with more informed traders. The relationship between the profit of momentum strategy and CEO pay-for-performance incentive is stronger among CEOs without the risk-taking incentive. Our results are robust for different sub-samples based on before and after Reg FD and Sarbanes–Oxley Act, even after controlling for the potential endogeneity. Further, our findings are consistent with the information diffusion explanation of momentum and the agency theory that incentivised CEOs tend to manipulate information by smoothing good news, concealing mildly bad news and accelerating the disclosure of extremely bad news.
Open Research
DATA AVAILABILITY STATEMENT
Data available on request due to privacy/ethical restrictions. The data that support the findings of this study are available on request from the corresponding author. The data are not publicly available due to privacy or ethical restrictions.
REFERENCES
- Aboody, D. & Kasznik, R. (2000) CEO stock option awards and the timing of corporate voluntary disclosures. Journal of Accounting and Economics, 29(1), 73–100.
- Aggarwal, R.K. & Samwick, A.A. (2003) Why do managers diversify their firms? Agency reconsidered. The Journal of Finance, 58(1), 71–118.
- Ahmed, A.S. & Safdar, I. (2018) Dissecting stock price momentum using financial statement analysis. Accounting and Finance, 58, 3–43.
- Almadi, M. & Lazic, P. (2016) CEO incentive compensation and earnings management: the implications of institutions and governance systems. Management Decision, 54(10), 2447–2461.
- Arellano, M. & Bond, S. (1991) Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. The Review of Economic Studies, 58(2), 277–297.
- Arellano, M. & Bover, O. (1995) Another look at the instrumental variable estimation of error-components models. Journal of Econometrics, 68(1), 29–51.
- Armstrong, C.S. & Vashishtha, R. (2012) Executive stock options, differential risk-taking incentives, and firm value. Journal of Financial Economics, 104(1), 70–88.
- Avramov, D., Chordia, T., Jostova, G. & Philipov, A. (2007) Momentum and credit rating. The Journal of Finance, 62(5), 2503–2520.
- Baber, W.R., Fairfield, P.M. & Haggard, J.A. (1991) The effect of concern about reported income on discretionary spending decisions: the case of research and development. The Accounting Review, 66(4), 818–829.
- Badertscher, B.A. (2011) Overvaluation and the choice of alternative earnings management mechanisms. The Accounting Review, 86(5), 1491–1518.
- Bali, T.G., Brown, S. & Tang, Y. (2016) Disagreement in economic forecasts and expected stock returns. Georgetown McDonough School of Business Research Paper No. 2407279.
- Barberis, N., Shleifer, A. & Vishny, R. (1998) A model of investor sentiment. Journal of Financial Economics, 49, 307–343.
- Bargeron, L.L., Lehn, K.M. & Zutter, C.J. (2010) Sarbanes-Oxley and corporate risk-taking. Journal of Accounting and Economics, 49(1–2), 34–52.
- Barroso, P. & Santa-Clara, P. (2015) Momentum has its moments. Journal of Financial Economics, 116(1), 111–120.
- Barth, M.E., Cram, D.P. & Nelson, K.K. (2001) Accruals and the prediction of future cash flows. The Accounting Review, 76(1), 27–58.
- Beasley, M.S., Carcello, J.V., Hermanson, D.R. & Neal, T.L. (2009) The audit committee oversight process. Contemporary Accounting Research, 26(1), 65–122.
- Bebchuk, L.A. & Cohen, A. (2005) The costs of entrenched boards. Journal of Financial Economics, 78(2), 409–433.
- Bebchuk, L.A., Cohen, A. & Ferrell, A. (2009) What matters in corporate governance? The Review of Financial Studies, 22(2), 783–827.
- Benmelech, E., Kandel, E. & Veronesi, P. (2010) Stock-based compensation and CEO (dis)incentives. The Quarterly Journal of Economics, 125(4), 1769–1820.
- Benmelech, E. & Moskowitz, T.J. (2010) The political economy of financial regulation: evidence from US state usury laws in the 19th century. The Journal of Finance, 65(3), 1029–1073.
- Bens, D.A. (2002) The determinants of the amount of information disclosed about corporate restructurings. Journal of Accounting Research, 40(1), 1–20.
- BenYoussef, N. & Khan, S. (2018) Timing of earnings restatements: CEO equity compensation and market reaction. Accounting and Finance, 58(2), 341–365.
- Bergstresser, D. & Philippon, T. (2006) CEO incentives and earnings management. Journal of Financial Economics, 80(3), 511–529.
- Bertrand, M., Duflo, E. & Mullainathan, S. (2004) How much should we trust differences-in-differences estimates? The Quarterly Journal of Economics, 119(1), 249–275.
- Bloomfield, R., O’Hara, M. & Saar, G. (2009) How noise trading affects markets: an experimental analysis. The Review of Financial Studies, 22(6), 2275–2302.
- Brickley, J.A., Linck, J.S. & Coles, J.L. (1999) What happens to CEOs after they retire? New evidence on career concerns, horizon problems, and CEO incentives. Journal of Financial Economics, 52(3), 341–377.
- Brock, W. A., & Mirman, L. J. (1973) Optimal economic growth and uncertainty: the no discounting case. International Economic Review, 14(3), 560–573.
10.2307/2525969 Google Scholar
- Brockman, P., Martin, X. & Unlu, E. (2010) Executive compensation and the maturity structure of corporate debt. The Journal of Finance, 65(3), 1123–1161.
- Bruns, W. & Merchant, K. (1990) The dangerous morality of managing earnings. Management Accounting, 72(2), 22–25.
- Burgstahler, D. & Dichev, I. (1997) Earnings management to avoid earnings decreases and losses. Journal of Accounting and Economics, 24(1), 99–126.
- Burns, N. & Kedia, S. (2006) The impact of performance-based compensation on misreporting. Journal of Financial Economics, 79(1), 35–67.
- Bushee, B.J. (1998) The influence of institutional investors on myopic R&D investment behavior. The Accounting Review, 73(3), 305–333.
- Canton, E., & Uhlig, H. (1999) Growth and the cycle: creative destruction versus entrenchment. Journal of Economics, 69(3), 239–266.
- Carhart, M.M. (1997) On persistence in mutual fund performance. The Journal of Finance, 52(1), 57–82.
- Carter, M.E., Lynch, L.J. & Tuna, I.R. (2007) The role of accounting in the design of CEO equity compensation. The Accounting Review, 82(2), 327–357.
- Chan, L.K., Jegadeesh, N. & Lakonishok, J. (1996) Momentum strategies. The Journal of Finance, 51(5), 1681–1713.
- Chava, S. & Purnanandam, A. (2010) CEOs versus CFOs: incentives and corporate policies. Journal of Financial Economics, 97(2), 263–278.
- Chen, Y. & Zhao, H. (2012) Informed trading, information uncertainty, and price momentum. Journal of Banking and Finance, 36(7), 2095–2109.
- Chen, Z. & Lu, A. (2017) Slow diffusion of information and price momentum in stocks: evidence from options markets. Journal of Banking and Finance, 75, 98–108.
- Cheng, Q. & Warfield, T. (2005) Equity incentives and earnings management. The Accounting Review, 80(2), 441–476.
- Chow, G. C. (1997) Dynamic economics: optimization by the Lagrange method. Oxford University Press.
10.1093/acprof:oso/9780195101928.001.0001 Google Scholar
- Cohen, D.A., Dey, A. & Lys, T.Z. (2008) Real and accrual-based earnings management in the pre- and post-Sarbanes-Oxley periods. The Accounting Review, 83(3), 757–787.
- Cohen, D.A. & Zarowin, P. (2010) Accrual-based and real earnings management activities around seasoned equity offerings. Journal of Accounting and Economics, 50(1), 2–19.
- Coles, J., Daniel, N.D. & Naveen, L. (2006) Managerial incentives and risk-taking. Journal of Financial Economics, 79(2), 431–468.
- Coles, J.L., Lemmon, M.L. & Meschke, J.F. (2012) Structural models and endogeneity in corporate finance: the link between managerial ownership and corporate performance. Journal of Financial Economics, 103(1), 149–168.
- Core, J. & Guay, W. (1999) The use of equity grants to manage optimal equity incentive levels. Journal of Accounting and Economics, 28(2), 151–184.
- Core, J. & Guay, W. (2002) Estimating the value of employee stock option portfolios and their sensitivities to price and volatility. Journal of Accounting Research, 40(3), 613–630.
- Da, Z., Gurun, U.G. & Warachka, M. (2014) Frog in the pan: continuous information and momentum. The Review of Financial Studies, 27(7), 2171–2218.
- Daniel, K., Hirshleifer, D. & Subrahmanyam, A. (1998) Investor psychology and security market under- and overreactions. The Journal of Finance, 53(6), 1839–1885.
- Daniel, K. & Moskowitz, T.J. (2016) Momentum crashes. Journal of Financial Economics, 122(2), 221–247.
- Dechow, P.M., Ge, W., Larson, C.R. & Sloan, R.G. (2011) Predicting material accounting misstatements. Contemporary Accounting Research, 28(1), 17–82.
- Dechow, P.M., Kothari, S.P. & Watts, R.L. (1998) The relation between earnings and cash flows. Journal of Accounting and Economics, 25(2), 133–168.
- Dechow, P.M. & Skinner, D.J. (2000) Earnings management: reconciling the views of accounting academics, practitioners, and regulators. Accounting Horizons, 14(2), 235–250.
10.2308/acch.2000.14.2.235 Google Scholar
- Dechow, P.M. & Sloan, R.G. (1991) Executive incentives and the horizon problem: an empirical investigation. Journal of Accounting and Economics, 14(1), 51–89.
- Dechow, P.M., Sloan, R.G. & Sweeney, A.P. (1995) Detecting earnings management. The Accounting Review, 70(2), 193–225.
- DeFond, M.L., Francis, J.R. & Wong, T.J. (2000) Auditor industry specialization and market segmentation: evidence from Hong Kong. Auditing: A Journal of Practice & Theory, 19(1), 49–66.
- Degeorge, F., Patel, J. & Zeckhauser, R. (1999) Earnings management to exceed thresholds. The Journal of Business, 72(1), 1–33.
- Demsetz, H. & Lehn, K. (1985) The structure of corporate ownership: causes and consequences. Journal of Political Economy, 93(6), 1155–1177.
- Doukas, J.A. & McKnight, P.J. (2005) European momentum strategies, information diffusion, and investor conservatism. European Financial Management, 11(3), 313–338.
- Easley, D., Hvidkjaer, S. & O'Hara, M. (2010) Factoring information into returns. Journal of Financial and Quantitative Analysis, 45(2), 293–309.
- Efendi, J., Srivastava, A. & Swanson, E.P. (2007) Why do corporate managers misstate financial statements? The role of option compensation and other factors. Journal of Financial Economics, 85(3), 667–708.
- Fama, E.F. (1980) Agency problems and the theory of the firm. Journal of Political Economy, 88(2), 288–307.
- Fama, E.F. & French, K.R. (1996) Multifactor explanations of asset pricing anomalies. The Journal of Finance, 51, 55–84.
- Fama, E.F. & French, K.R. (2015) A five-factor asset pricing model. Journal of Financial Economics, 116(1), 1–22.
- Fama, E.F. & MacBeth, J.D. (1973) Risk, return, and equilibrium: empirical tests. Journal of Political Economy, 81(3), 607–636.
- Francis, B.B., Hasan, I., Hunter, D.M. & Zhu, Y. (2017) Do managerial risk-taking incentives influence firms' exchange rate exposure? Journal of Corporate Finance, 46, 154–169.
- Fudenberg, D. & Tirole, J. (1995) A theory of income and dividend smoothing based on incumbency rents. Journal of Political Economy, 103(1), 75–93.
- Garen, J.E. (1994) Executive compensation and principal-agent theory. Journal of Political Economy, 102(6), 1175–1199.
- Gaver, J.J., Gaver, K.M. & Austin, J.R. (1995) Additional evidence on bonus plans and income management. Journal of Accounting and Economics, 19(1), 3–28.
- Gibbons, R. & Murphy, K.J. (1992) Optimal incentive contracts in the presence of career concerns: theory and evidence. Journal of Political Economy, 100(3), 468–505.
- Graham, J.R., Harvey, C.R. & Rajgopal, S. (2005) The economic implications of corporate financial reporting. Journal of Accounting and Economics, 40(1–3), 3–73.
- Griffin, J.M., Ji, X. & Martin, J.S. (2003) Momentum investing and business cycle risk: evidence from pole to pole. The Journal of Finance, 58(6), 2515–2547.
- Griffin, J.M., Kelly, P.J. & Nardari, F. (2010) Do market efficiency measures yield correct inferences? A comparison of developed and emerging markets. The Review of Financial Studies, 23(8), 3225–3277.
- Hameed, A., Hong, D. & Warachka, M. (2008) Momentum and informed trading. EFA 2008 Athens meetings paper.
- Hanlon, M., Rajgopal, S. & Shevlin, T. (2003) Are executive stock options associated with future earnings? Journal of Accounting and Economics, 36(1–3), 3–43.
- Harford, J., Mansi, S.A. & Maxwell, W.F. (2008) Corporate governance and firm cash holdings in the US. Journal of Financial Economics, 87(3), 535–555.
- Hart, O. (2009) Regulation and Sarbanes-Oxley. Journal of Accounting Research, 47(2), 437–445.
- He, Z. & Krishnamurthy, A. (2012) A model of capital and crises. Review of Economic Studies, 79(2), 735–777.
- Healy, P.M. & Wahlen, J.M. (1999) A review of the earnings management literature and its implications for standard setting. Accounting Horizons, 13(4), 365–383.
10.2308/acch.1999.13.4.365 Google Scholar
- Hill, R.C., Griffiths, E.W. & Lim, G.C. (2008) Principles of Econometrics. New York: Wiley.
- Holmstrom, B. (1999) Managerial incentive problems: a dynamic perspective. The Review of Economic Studies, 66(1), 169–182.
- Hong, H., Lim, T. & Stein, J.C. (2000) Bad news travels slowly: size, analyst coverage, and the profitability of momentum strategies. The Journal of Finance, 55(1), 265–295.
- Hong, H. & Stein, J.C. (1999) A unified theory of underreaction, momentum trading, and overreaction in asset markets. The Journal of Finance, 54(6), 2143–2184.
- Hou, K., Xue, C. & Zhang, L. (2015) Digesting anomalies: an investment approach. The Review of Financial Studies, 28(3), 650–705.
- Jayaraman, S. & Milbourn, T.T. (2012) The role of stock liquidity in executive compensation. The Accounting Review, 87(2), 537–563.
- Jegadeesh, N. & Titman, S. (1993) Returns to buying winners and selling losers: implications for stock market efficiency. The Journal of Finance, 48(1), 65–91.
- Jegadeesh, N. & Titman, S. (2001) Profitability of momentum strategies: an evaluation of alternative explanations. The Journal of Finance, 56(2), 699–720.
- Jensen, M.C. & Murphy, K.J. (1990) Performance pay and top-management incentives. Journal of Political Economy, 98(2), 225–264.
- Jin, L. (2002) CEO compensation, diversification, and incentives. Journal of Financial Economics, 66(1), 29–63.
- John, T.A. & John, K. (1993) Top-management compensation and capital structure. The Journal of Finance, 48(3), 949–974.
- Kim, Y., Li, H. & Li, S. (2015) CEO equity incentives and audit fees. Contemporary Accounting Research, 32(2), 608–638.
- Klock, M. S., Mansi, S. A., & Maxwell, W. F. (2005) Does corporate governance matter to bondholders?. Journal of Financial and Quantitative Analysis, 40(4), 693–719.
- Kothari, S.P., Leone, A.J. & Wasley, C.E. (2005) Performance matched discretionary accrual measures. Journal of Accounting and Economics, 39(1), 163–197.
- Larcker, D.F. & Rusticus, T.O. (2010) On the use of instrumental variables in accounting research. Journal of Accounting and Economics, 49(3), 186–205.
- Lewellen, K. (2006) Financing decisions when managers are risk averse. Journal of Financial Economics, 82(3), 551–589.
- Lilienfeld-Toal, U.V. & Ruenzi, S. (2014) CEO ownership, stock market performance, and managerial discretion. The Journal of Finance, 69(3), 1013–1050.
- Liu, Y. & Mauer, D.C. (2011) Corporate cash holdings and CEO compensation incentives. Journal of Financial Economics, 102(1), 183–198.
- Low, A. (2009) Managerial risk-taking behavior and equity-based compensation. Journal of Financial Economics, 92(3), 470–490.
- Manso, G. (2011) Motivating innovation. The Journal of Finance, 66(5), 1823–1860.
- Merhebi, R., Pattenden, K., Swan, P.L. & Zhou, X. (2006) Australian chief executive officer remuneration: pay and performance. Accounting and Finance, 46(3), 481–497.
- Murphy, K.J. (1986) Incentives, learning, and compensation: a theoretical and empirical investigation of managerial labor contracts. The Rand Journal of Economics, 17, 59–76.
- Nikolaev, V. & Van Lent, L. (2005) The endogeneity bias in the relation between cost-of-debt capital and corporate disclosure policy. European Accounting Review, 14(4), 677–724.
10.1080/09638180500204624 Google Scholar
- O'Connor, M.L. & Rafferty, M. (2010) Incentive effects of executive compensation and the valuation of firm assets. Journal of Corporate Finance, 16(4), 431–442.
- Palia, D. (2001) The endogeneity of managerial compensation in firm valuation: a solution. The Review of Financial Studies, 14(3), 735–764.
- Peasnell, K.V., Pope, P.F. & Young, S. (2000) Accrual management to meet earnings targets: UK evidence pre- and post-Cadbury. The British Accounting Review, 32(4), 415–445.
10.1006/bare.2000.0134 Google Scholar
- Peng, L. & Roell, A. (2008) Manipulation and equity-based compensation. American Economic Review, 98(2), 285–290.
- Peng, L. & Roell, A. (2014) Managerial incentives and stock price manipulation. The Journal of Finance, 69(2), 487–526.
- Peng, L., Roell, A. & Tang, H. (2016) CEO incentives: measurement, determinants, and impact on performance. CEPR Discussion Papers 11417.
- Rauh, J.D. (2006) Investment and financing constraints: evidence from the funding of corporate pension plans. The Journal of Finance, 61(1), 33–71.
- Ribstein, L.E. (2002) Market vs. regulatory responses to corporate fraud: a critique of the Sarbanes-Oxley Act of 2002. The Journal of Corporation Law, 28(1), 1–67.
- Roychowdhury, S. (2006) Earnings management through real activities manipulation. Journal of Accounting and Economics, 42(3), 335–370.
- Shen, C.H.H. & Zhang, H. (2013) CEO risk incentives and firm performance following R&D increases. Journal of Banking and Finance, 37(4), 1176–1194.
- Shin, H.H. & Stulz, R.M. (2000) Firm value, risk, and growth opportunities. NBER Working Paper No. 7808.
- Smith, C.W., Jr. & Watts, R.L. (1992) The investment opportunity set and corporate financing, dividend, and compensation policies. Journal of Financial Economics, 32(3), 263–292.
- Stock, J.H. & Watson, M.W. (2003) Forecasting output and inflation: the role of asset prices. Journal of Economic Literature, 41(3), 788–829.
- Tirole, J. (2010) The theory of corporate finance. Princeton, NJ: Princeton University Press.
- Walkshäusl, C. (2019) The fundamentals of momentum investing: European evidence on understanding momentum through fundamentals. Accounting and Finance, 59, 831–857.
- Wintoki, M.B., Linck, J.S. & Netter, J.M. (2012) Endogeneity and the dynamics of internal corporate governance. Journal of Financial Economics, 105(3), 581–606.
- Yan, Y. & Zhang, S. (2012) An improved estimation method and empirical properties of the probability of informed trading. Journal of Banking and Finance, 36(2), 454–467.
- Yermack, D. (1996) Higher market valuation of companies with a small board of directors. Journal of Financial Economics, 40(2), 185–211.
- Zang, A.Y. (2012) Evidence on the trade-off between real activities manipulation and accrual-based earnings management. The Accounting Review, 87(2), 675–703.
- Zalewska, A. (2014) Gentlemen do not talk about money: remuneration dispersion and firm performance relationship on British boards. Journal of Empirical Finance, 27, 40–57.
- Zhang, L. (2017) The investment CAPM. European Financial Management, 23(4), 545–603.
- Zhang, X.F. (2006) Information uncertainty and stock returns. The Journal of Finance, 61(1), 105–137.
