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Do Equity-Based Incentives Induce CEOS to Manage Earnings To Report Strings of Consecutive Earnings Increases?

This study provides empirical evidence that equity-based incentives (stock and stock options) encourage CEOs to manage earnings to increase short run stock prices so that they can cash out a portion of their equity holdings at inflated prices. CEOs who hold high equity-based incentives are more likely to manage earnings to report strings of consecutive earnings increases and sell stocks in approximately two to six quarters prior to a break in a string of consecutive earnings increases. These effects are stronger for firms whose stock prices are very sensitive to earnings. Consistent with avoiding the perception of illegal insider trading, CEOs with high equity-based incentives do not sell shares in the quarter immediately prior to the break.