Executive Compensation and Corporate Fraud
Introduction:
The past decade has been witness to some of the worst accounts of corporate fraud ever recorded, with multi-billion dollar companies such as Enron, Tyco, and World-com involved in serious financial scandals. CEOs and senior executives are often the driving force behind such unscrupulous activities by adopting shady accounting practices and other forms of short-termist actions for the purpose of increasing their firm’s stock price and their own personal wealth. The following paper will investigate whether there is a link between executive compensation structures and fraud or misreporting. Through the analysis of four academic articles, I will show that the evidence which links compensation tools tied to stock market based incentives, and a greater prevalence of corporate fraud, has in fact been mixed. I will conclude by reviewing whether there are any policy implications of these studies.
Are Executive Compensation strategies linked to corporate fraud?
Corporate fraud is not a new phenomenon and white collar crimes are as old as white collar professions themselves. However, the significant number and magnitude of criminal offences committed by high powered CEOs and senior executives early on in this young century warrants a closer examination. The articles presented in this study attempt to determine whether there exists a clear link between executive compensation and fraud or misreporting, and the evidence has been mixed: One study finds no link between equity based incentives and fraud (Erickson, Hanlon & Maydew, 2006). Two studies examine the link between misreporting of accounting statements and CEO stock options, and find a clear correlation between the two, although one of the studies identifies only a limited link. (Burns & Kedia, 2006; Efendi, Srivastava, & Swanson, 2007) The final study concludes that the likelihood of fraud increases when executive compensation is tied to stock market based incentives (Denis, Hanouna & Sarin, 2006).
The past decade has been witness to some of the worst accounts of corporate fraud ever recorded, with multi-billion dollar companies such as Enron, Tyco, and World-com involved in serious financial scandals. CEOs and senior executives are often the driving force behind such unscrupulous activities by adopting shady accounting practices and other forms of short-termist actions for the purpose of increasing their firm’s stock price and their own personal wealth. The following paper will investigate whether there is a link between executive compensation structures and fraud or misreporting. Through the analysis of four academic articles, I will show that the evidence which links compensation tools tied to stock market based incentives, and a greater prevalence of corporate fraud, has in fact been mixed. I will conclude by reviewing whether there are any policy implications of these studies.
Are Executive Compensation strategies linked to corporate fraud?
Corporate fraud is not a new phenomenon and white collar crimes are as old as white collar professions themselves. However, the significant number and magnitude of criminal offences committed by high powered CEOs and senior executives early on in this young century warrants a closer examination. The articles presented in this study attempt to determine whether there exists a clear link between executive compensation and fraud or misreporting, and the evidence has been mixed: One study finds no link between equity based incentives and fraud (Erickson, Hanlon & Maydew, 2006). Two studies examine the link between misreporting of accounting statements and CEO stock options, and find a clear correlation between the two, although one of the studies identifies only a limited link. (Burns & Kedia, 2006; Efendi, Srivastava, & Swanson, 2007) The final study concludes that the likelihood of fraud increases when executive compensation is tied to stock market based incentives (Denis, Hanouna & Sarin, 2006).
Bibliography: Burns, N., Simi K. (2006). The impact of performance-based compensation on misreporting, Journal of Financial Economics, 79, 35–67. Denis, D., Hanouna, P., Sarin, A. (2006). Is there a dark side to incentive compensation? Journal of Corporate Finance, 12: 467-488. Erickson, M., Hanlon, M., Maydew, E. (2006). Is there a Link between Executive Equity Incentives and Accounting Fraud?, Journal of Accounting Research, 44 (1), 113-143 Efendi, J., Srivastava, A., Swanson, E.. (2007). Why do corporate managers misstate financial statements? The role of option compensation and other factors*. Journal of Financial Economics, 85(3), 667-708