An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Mary Lea McAnally
Texas A&M University

Anup Srivastava
Texas A & M University

Connie D. Weaver
Texas A & M University

Abstract: We examine whether managers with larger stock-option grants are more likely to miss earnings targets, and if so, whether earnings management is implicated. Anecdotal evidence and surveys suggest that managers believe missing an earnings target can cause stock price slides. Thus, missing a target can reward executives via a lower strike price. We collect data for 1,744 firms for 1993 through 2004. We find that CEOs’ grants increase in number and in dollar value when firms report small losses or small earnings declines. We use book-tax differences to proxy for earnings management and find that firms manage earnings downward around grant dates. Most importantly, we document that grants create strong incentives for executives to miss earnings targets via downward earnings management. To the extent that missed targets precipitate larger negative price reactions, they provide a greater increase in option grant value than managing earnings at other points in the earnings distribution.

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