Review of Finance Advance Access originally published online on May 9, 2008
Review of Finance 2009 13(1):115-145; doi:10.1093/rof/rfn014
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Managerial Incentives and Corporate Fraud: The Sources of Incentives Matter*
1 Texas A&M University
2 Georgia State University
3 York University
Operating performance and stock return results imply that managers who commit fraud anticipate large stock price declines if they were to report truthfully, which would cause greater losses for managerial stockholdings than for options because of differences in convexity. Fraud firms have significantly greater incentives from unrestricted stockholdings than control firms do, and unrestricted stockholdings are their largest incentive source. Our results emphasize the importance of the shape and vesting status of incentive payoffs in providing incentives to commit fraud. Fraud firms also have characteristics that suggest a lower likelihood of fraud detection, which implies lower expected costs of fraud.
JEL Classification: M52, G34, K42, M41
* We thank Daniel Chi, Hao Li, Huihua Li, Jessica Rutherford, Stephen Smith, Brooke Stanley, and Lingling Wang for excellent research assistance, and Andrew Christie, Gerry Gay, Jay Hartzel, Jayant Kale, Omesh Kini, Scott Lee, Adam Lei, Lin Peng, Ernst Maug, Kevin Murphy, Steve Smith, Bob Parrino, Jeff Pontiff, Zacharias Sautner, Josef Zechner (the editor), two anonymous referees, and seminar participants at the 2006 European Finance Association Meeting, University of Arizona, Claremont McKenna College, Georgia State University, University of Iowa, Notre Dame University, University of Waterloo, Queen's University, McMaster University, and Drexel University for helpful comments. Johnson and Tian thank the Social Sciences and Humanity Research Council of Canada for financial support.