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

Qiang Cheng
University of British Columbia

David B. Farber
University of Missouri - Columbia

Abstract: Prior research finds that earnings restatements are linked to CEOs’ excessive option-based compensation and equity holdings. In this paper, we investigate whether firms that experience earnings restatements recontract with their CEOs to reduce their option-based compensation and whether this results in improved firm performance. Based on 289 restatement firms over the period 1997-2001, we find that the proportion of CEOs’ compensation in the form of options declines significantly in the two years following the restatement. Furthermore, we document that this reduction is associated with subsequent improvements in both operating and market performance. Our findings provide insights into the design and efficacy of CEO compensation contracts.

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