Bank Executive Stock Option Compensation and Earnings Management by Discretionary Loan Loss Provisions
Asian Tax Journal Vol. 10 No. 2 (2009), pp. 75-112
Abstract
The purpose of this paper is to examine executive stock option granting banks prior to the exercise of stock options and earnings management practices by focusing on discretionary loan loss provisions for banks. During the period of 2003 thru 2007, we empirically analyze the effect of the executives' exercisable stock option on the earnings management of bank industry in Korea. After we classify types of granted stock options and the degree of ownership dispersion, we analyze the relationship between types of these and earnings management focusing on exercisable time. So the empirical results are summarized as follows. First, the level of executive's exercisable stock options have negatively significant effect on discretionary loan loss provisions. These results imply that managers tend to increase reported earnings prior to exercise for maximizing expected their wealth. Second, executive granted fixed stock options have negatively significant effect on discretionary loan loss provisions comparing with performance-based stock options. This shows fixed stock options more increase managers' opportunistic behavior and exist the possibility of increasing reported earings rather than performance-based stock options. Finally, the level of executive's exercisable stock options with higher ownership dispersion have negatively significant effect on discretionary loan loss provisions. The evidence suggests that banks with higher ownership dispersion less control over managers' opportunistic behavior comparing with lower one and so more allow mangers to manage earings. This study showed that stock option compensation has possibilities to adjust earnings prior to exercised. In addition to the results suggest that more used performance-based stock options and lower ownership dispersion's banks mitigate earnings management. At present state where advantages and disadvantages of using executive stock option compensation system being scrutinized, the study would provide a great implications for bank regulatory agencies.
Keywords
- stock option
- earnings management
- ownership dispersion
- loan loss provision
- bank
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