2009/9 19 S2 1 34

Equity Incentives, Earnings Management and Insider Trading: An Empirical Investigation of the Agency Costs of Overvalued Equity
Jia-Xun Jiang, Associate Professor, Department of Accounting, Fu Jen Catholic University Received 2007/7, Final revision received 2008/10

1997

2005

Jensen (2005)

Abstract This study investigates the empirical implications of the agency theory of overvalued equity (Jensen, 2005). It finds that after controlling for other earnings management incentives, firms with overvalued equity have larger abnormal accruals than non-overvalued firms. Besides, equity incentives provided for managers of overvalued firms exacerbate opportunistic earnings management. I also find that managers with higher equity incentives or undertaking more aggressive earnings management are more likely to take large share selling in the following year and that effects are more pronounced for overvalued firms. This study provides empirical support for the agency theory of overvalued equity (Jensen, 2005), as Jensen said, "Equity-based compensation cannot solve the problem because it makes the problem worse, not better (for overvalued firms)". Keywords overvalued equity, equity incentive, earnings management

21

(Enron) Jensen (2005)

(WorldCom)

1)

(Agency Costs of Overvalued Equity)

Jensen (2005)

2)

1997

2005

1999 7 U.S.$40 2000 8 U.S.$90 U.S.$700 2000 8 2001 12 16 U.S.$90 U.S.$1 1998 MCI U.S.$49 U.S.$370 1999 U.S.$64 U.S.$1,250 2002 6 U.S.$1 1999 12 NT$85.5 2000 4 NT$368 NT$402.8 2001 2004 6 NT$29.6 2000 2 NT$60 2000 6 NT$512 NT$596 2001 2004 9 NT$8 CEO U.S.$140 2000 Enron Enron 3.5% Kenneth Lay U.S.$123 U.S.$924 Enron Enron 1999 2001 1999 12 10.6% 2004 2 6,500,000 Enron Enron Kenneth Lay 2001 2000 Enron U.S.$70 U.S.$20 4.5% 6.1% 2002 2

15.5% 7.8%

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(1) (2)

(3)

(4) Jensen (2005)

Jensen (2005) Costs of Overvalued Equity Hypothesis)

(The Agency

(Managerial Heroin)

Jensen (2005)
3

Kothari

Loutskina

Nikolaeu (2006)

1963

2004

(Accrual Anomaly) (Sloan, 1996) 18% -3.6% ( Skantz Houmes (2006) 1990 2005 )

Efendi 2001 2002 GAAP

Srivastava

Swanson (2007) GAAP GAAP

12 (GAO) (2002) GAAP

20% Badertscher (2008) General Accounting Office GAAP GAAP GAAP GAAP ( Jensen (2005) 2006)

H1

19

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(Lambert & Larcker, 1987; Morck, Shleifer, & Vishny, 1988; Hanlon, Rajgopal, & Shevlin, 2003) alignment Effect) Cheng Warfield (CW) (2005) (Incentive-

(Idiosyncratic Risk of the Firm) CEO CW

(Meet or Just Beat) CEO CEO CW CEO (Meet or Just Beat) Cheng Warfield (2005) Warfield (2005) H2a

H2a
Cheng

H2b H2c

Jensen (2004, 2005)

5

Efendi et al. (2007) GAAP CEO CEO CEO CEO Efendi et al. (2007) CEO CEO GAAP

Cheng Warfield (2005) H3a

H3a
Kothari et al. (2006)

Kothari et al. (2006) Efendi et al. (2007)

Cheng

Warfield (2005)

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H3b

H3c

1997 1993 2007 (

3)

2005

TEJ 1% 3,510 (Firm-year) (Firm-year) 4,292 37.1% 99%

Kothari et al. (2006) (BM)

Dechow

Dichev (2002)

Efendi et al. (2007) Skantz

Badertscher (2008)

Houmes (2006)

Lyon

Barber (BM) 4 30 4

Tsai (1999)

Kothari et al. (2006) (SIZE)

30 )

(BM) ( BM (Reference Portfolio) t-1 5 1 t 4 30

1 BM

1 BM t-1 3 3 9

30

(ABRETt-1) t-1 Frankel Lee (1998)

12 (
4)

Frankel V )

Lee (1998) (V/P) V/P

(Ohlson, 1995; Feltham & Ohlson, 1995) (Fundamental Value V/P

(1)

Lyon et al. (1999) ( Kothari et al. (2006) t 5 9 t+1 4 12 5 ) 45

9 1%

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Vit-1 12 t 10 t 4 ROE ROE Vit-1 1.0 30 31 i t-2 CAPM

i t+2

30 i t

Bit rit TEJ

i i

t ROEit+2

ROEit

Beta Beta Frankel ROEit+2 t ABRET t-1 4 Lee (1998) rit 30 V_Pt-1 V_P t-1 (1) ABRETt-1 > 0 V_Pt-1

TEJ

( t+3

) Beta 5% ROE (1)

(Mean Reverting) 0 V_Pt-1

(1) V_Pt-1

OVER_VALUEt-1 2/5 1 (2) V_Pt-1 < 1.0

ABRETt-1 2/5 OVER_VALUEt-1= ABRETt-1 2/5 UNDER_VALUEt-1 = 0 (1)

OVER_VALUEt-1 = 0 UNDER_VALUEt-1 2/5 UNDER_VALUEt-1 = 1 (2) V_Pt-1 > 1.0 (1) ABRETt-1 < 0 V_Pt-1

(OWNERSHIP_MGR) (SK_BONUS_MGR) (OPTION_MGR) )

(2) (3) ( ( Cheng ) Warfield (2005) SK_BONUS_MGR 2004

OWNERSHIP_MGR

2004 2004~2005

2005

2004

(SK_BONUS_MGRP) 2004
9

2004

5)

2001 2001 0

2001

(2)

Ball Model (Jones, 1991)

Shivakumar (2006) Jones Model (Jones, 1991)

(Piecewise Linear) Jones

(3)

TACC= 1 Ball (4) 30 1 12

=( GPPE= 31 5 NEG=1 NEG=1

) RET <0 (3)

REV= RET= 0

Shivakumar (2006)

(ABACC)

(4)

TEJ TEJ

( (

) )

2004~2005 SK_BONUS_MGRP

SK_BONUS_MGRP

10

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t+1 NETSALE_MGRt+1

t+2 (NETSALE_MGR t+1 )

(5)

NETSALENUM_MGRi SHARENUM it SHARENUM_MGRi SK_BONUSNUM_MGRi SK_BONUSNUM_MGRi i

i i t SK_DIVNUM_MGRi t

i TEJ

SK_DIVNUM_MGRi SK_DIVNUM_MGR SK_BONUSNUM_MGR

NETSALE_MGRt+1 ABSALE_MGRt+1=1 ABBUY_MGRt+1=1 NETSALE_MGRt+1 NETSALE_MGRt+1 > 0 A B S A L E _ M G R t+1= 0 NETSALE_MGRt+1 NETSALE_MGRt+1 < 0 ABBUY_MGRt+1=0

H1

H2a

H3a

(6)

11

(6) OVER_VALUE OVER_VALUE H2a

3

ABACC EQ_INCENTIVE EQ_INCENTIVE H3a H1 >0 UNDER_VALUEt-1 (Kothari et al., 2006) (2) (OWNERSHIP_DIR) (LEV) (NOA) 2003; Jiang, 2007) / (DeFond & Jiambalvo, 1994) = (SIZE)
1

> 0

> 0

4 4

(6)

(1)

(PBR)

(BETA) (Fan & Wong, 2002; LEV=

(Ahmed, Billings, Morton, & Harris, 2002; Jiang & Yeh, 2007) SIZE= (
6)

BETA= PBR=

(Warfield, Wild, & Wild, 1995)

NOAt-1= Simko (2002) =( ) (3) Dechow -

/ ) (

Barton PBR Francis

BETA Dichev (2002)

(Lambert & Larcker, 1987; Murphy, 1999) LaFond Olsson Schipper (2004)

Ashbaugh , Geiger North (2006)

Lafond

Mayhew (2003),

12

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(SIZE) (INT_INTENSITY) (LOSS) ) OP_CYCLE= (SD_CFO) (

(OP_CYCLE)

(CAP_INTENSITY)

INT_INTENSITY= CAP_INTENSITY= SD_CFO= LOSS=1 (Take a Big Bath) (ELECTRONIC) 0 /

(Francis et al., 2004; Penman & Zhang, 2002)

) 0

ELECTRONIC =1

H2b

H2c

H3b

H3c

(7)

(7) Probit )

NETSALE_MGRt+1 (OLS NETSALE_MGRt+1 t

ABTRADE_MGRt+1 (Ordered

(NETSALE_MGR t+1 > 0) (NETSALE_MGRt+1 < 0)

13

Ordered Probit Model ABTRADE_MGR t+1 ABTRADE_MGR t+1 =1 ABTRADE_MGR t+1 =-1 ABBUY_MGRt+1=0 ABTRADE_MGRt+1=0 (7) (EQ_INCENTIVE) (H2b) (H3b) Cheng NEG_ABACC=ABACC Warfield (2005) POS_ABACC=0 H2b ( ) H3b
6 4

ABSALE_MGR t+1 =1 ABBUY_MGR t+1 =1 ABSALE_MGR t+1 =0

Ordered Probit Model (ABACC) (H2c) (H3c) H2b

3

>0

ABACC>0 ABACC<0 H2c

POS_ABACC=ABACC

NEG_ABACC=0

> 0 H3c )
1

5 7

> 0 ( ( ) (1) SIZE=

> 0 <0 (7)

( >0
2

) Lee

Lakonishok (2) PBR=

(2001) Rozeff

Cheng

Warfield (2005) Cheng ( CFO)= ) Warfield (2005) (3) ( (RET)

Zaman (1998)

(Contrarian Trading Strategy) (Lakonishok & Lee, 2001; Cheng & Warfield, 2005)

1 14%
14

1 16%

-0.56%~0.15%

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1.57% ) 0.15% 24% 0.03% 0.191 30% Beta 0.8 34% 1.33%

( 0.08% 0.31% 1.39

2 (1) (PSR) PBR 2.93 PER

V_P 2 (PBR) 50 PSR 3.26 (PER)

(PBR) (SIZE) (2) (p<0.01)

(PER) (GROWTH)

(PSR) (BETA) 2 H1 (p<0.01) 0 (3)

2 (ABSALE_MGRt+1=1)

(4)

15

16

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17

3 ( )

Kothari et al. (2006) ( 6.8% (p<0.05) 0 0 10.5% 3.1% -4.0%

3 0) ( 0 -3.1% ( ) 0 ) (1)

(p<0.01) H1 (2) 3

(p<0.01) (ABSALE_MGRt+1=1) (5)

H2a

(3) (p<0.10) (p<0.01) H2c

(ABBUY_MGR=1) ABBUY_MGR = 0) (ABSALE_MGR=1) 4 0) (1) H2b (

(NETSALE_MGR<0 & 0 (NETSALE_MGR =0) (NETSALE_MGR>0&ABSALE_MGR=0) 4 ) (2) (3) H2c (4) (

4
18

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7)

5 (1)

(6) Panel B

5 Panel A (OVER_VALUEt-1) >0 H1 (2)

(UNDER_VALUEt-1)

(EQ_INCENTIVEt)

>0 (p<0.01)

H2a

(OWNERSHIP_MGRt) (OPTION_MGRt) Wald test OWNERSHIP_MGRt (F=5.68, p<0.02)

(SK_BONUS_MGRt) (Panel B) >0 (p<0.01) SK_BONUS_MGR t (

8)

(3) H3a

(Panel B) >0

(1) H1 H2a H2c (2) (3)

H2b

(OPTION_MGR t) 178 5%

19

(p<0.01) (3) 5

(OVER_VALUEt-1=1) (UNDER_VALUE t-1 =1) UNDER_VALUEt-1=0) UNDER_VALUEt-1 p<0.05) H3a 0.083 (t=0.083, p>0.10) ) 0.254 (t=2.10, 0.048 (t=0.048, p>0.10) (OVER_VALUE t-1 =0 & (6) ( OVER_VALUEt-1

6 Ordered Probit

(7)

Ordered Probit

OLS ( )

( (p<0.05)

H2b H3b

H2c

(p<0.05) 6 OLS

H3c

OLS (p<0.05) Ordered Probit 6 (7) OLS H2b H3c

H2b

H2c H3b H 3c (9)

H2b

H3b

20

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21

22

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White

23

White

24

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25

Kothari et al. (2006) Kothari et al. (2006) H3c

(8)

(8)

7 Panel A

Kothari et al. (2006)

H2c

Kothari et al. (2006) 7 Panel B (OVER_VALUEt-1 =1) ( OVER_VALUEt-1 ) 7 7 Beta

26

H3c

(UNDER_VALUEt-1 =1) (8) OVER_VALUEt-1 UNDER_VALUEt-1

(OVER_VALUEt-1 =0 & UNDER_VALUEt-1 = 0)

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F-statistic

F-statistic

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White

Ball Model (Jones, 1991)

Shivakumar (2006)

Jones Model (Jones, 1991) (1) Jones

Jones Model (Jones, 1991) (2) Ball Shivakumar (2006) Jones Model (Jones, 1991) H2a DD Model

DD Model (Dechow & Dichev, 2002) H1 H3a

H1 Model

H 2a

H 3a

Jones model (Jones, 1991) ( 2004 2004

DD
9)

2004 2005

Cheng (2006) (Lakonishok & Lee, 2001;

Warfield (2005)

Kothari et al. 2003)

(6) Jones Model Jones Model DD Model

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(7) (NETSALE_DIRt+1) (OWNERSHIP_DIRt) (NETSALE_MGRt+1) (EQ_INCENTIVEt)

Jensen (2005) 1997 2005 Jensen (2005)

Jensen (2005) Jensen (2005)

Lambert (2006) ( ( ) )

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