The Impact of Earnings Management on CEO Equity Incentives

This paper investigates whether firms adjust CEO equity incentives in response to prior earnings management. I show that the risk-taking incentives from new equity grants are lower for firms with higher prior real earnings management (REM), but not for firms with higher prior accruals-based earnings management (AEM). These adjustments are associated with sustained earnings management over the three years before the grant, but not with transitory earnings management. Additionally, I show that firms with higher institutional ownership primarily drive the negative relationship between REM and AEM and risk-taking incentives from new equity grants. My results are consistent with firms altering compensation incentives to restrain managers’ value-reducing behavior, in part, due to the monitoring of institutional investors.