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| Home | Stanford Faculty Bio | Vita | Research | Teaching | Contact | Rule 10b5-1 | |||
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Publications
Chief Executive Officer Equity Incentives and Accounting Irregularities
(with Christopher Armstrong and David Larcker)
Journal of Accounting Research, forthcoming
Abstract:
This study examines whether Chief Executive Officer (CEO) equity-based holdings and compensation provide incentives to manipulate accounting reports. While several prior studies have examined this important question, the empirical evidence is mixed and the existence of a link between CEO equity incentives and accounting irregularities remains an open question. Because inferences from prior studies may be confounded by assumptions inherent in research design choices, we use propensity-score matching and assess hidden (omitted variable) bias within a broader sample. In contrast to most prior research, we do not find evidence of a positive association between CEO equity incentives and accounting irregularities after matching CEOs on the observable characteristics of their contracting environments. Instead, we find some evidence that accounting irregularities occur less frequently at firms where CEOs have relatively higher levels of equity incentives.
Market Reaction to the Adoption of IFRS in Europe
(with Christopher Armstrong, Mary Barth, and Edward Riedl)
The Accounting Review, January 2010 forthcoming
Abstract:
This study examines European stock market reactions to sixteen events associated with the adoption of International Financial Reporting Standards (IFRS) in Europe. European IFRS adoption represented a major milestone towards financial reporting convergence yet spurred controversy reaching the highest levels of government. We find an incrementally positive reaction for firms with lower quality pre-adoption information, which is more pronounced in banks, and with higher pre-adoption information asymmetry, consistent with investors expecting net information quality benefits from IFRS adoption. We find an incrementally negative reaction for firms domiciled in code law countries, consistent with investors’ concerns over enforcement of IFRS in those countries. Finally, we find a positive reaction to IFRS adoption events for firms with high quality pre-adoption information, consistent with investors expecting net convergence benefits from IFRS adoption.
SEC Rule 10b5-1 and Insiders' Strategic Trade
Management Science, February 2009
Abstract:
The SEC enacted Rule 10b5-1 to deter insiders from trading with private information, yet also protect insiders' preplanned, non-information-based trades from litigation. Despite its requirement that insiders plan trades when not privately informed, the Rule appears to enable strategic trade. Participating insiders' sales systematically follow positive and precede negative firm performance, generating abnormal forward-looking returns larger than those earned by non-participating colleagues. The observed association does not appear to be explained by market transaction disclosure response, “predictable” reversion following positive performance, or general periodic price declines. There is evidence, however, that a substantive proportion of randomly drawn plan initiations are associated with pending adverse news disclosures. There is also evidence that early sales plan terminations are associated with pending positive performance shifts, reducing the likelihood that insiders' sales execute at low prices. Collectively, this suggests that, on average, trading within the Rule does not solely reflect uninformed diversification.
An Analysis of Insiders' Use of Prepaid Variable Forward Transactions
(with Steve Matsunaga and Eric Yeung)Journal of Accounting Research, December 2007
Abstract:
This study examines firm performance surrounding insiders' Prepaid Variable Forward (PVF) transactions to infer insiders' information when they enter these off-market contracts. PVFs allow insiders to hedge downside risk, share performance gains, and obtain immediate large-sum cash payments for investment or consumption. On average, PVF transactions cover 30% of a sample insider's firm-specific wealth ($22 million), which is substantially larger than a typical open-market sale. PVFs systematically follow strong firm performance and precede degraded stock and earnings performance. PVFs also precede periods of negative abnormal returns relative to potential alternative investments. The documented association between PVFs and performance declines does not appear to result from the market's response to transaction disclosure, participant self-selection, or general price reversals. Thus, evidence suggests that insiders use PVFs to diversify firm-specific holdings in anticipation of performance declines.
Selected Working Papers
Timing of Employee Stock Option Exercises and the Cost of Stock Option Grants
(with Christopher Armstrong and David Larcker)
Abstract:
This study examines how employees' option exercise behavior affects firms' cost estimates of their employee stock option grants. Prior research suggests that utility-based models of early option exercise do not yield different cost estimates than those produced by simple adjustments of the exercise time within the Black-Scholes option pricing model. This study shows, however, that the accuracy of option exercise timing estimates is significantly improved when exercise rates are modeled as a function of behavioral and economic factors such as attainment of performance benchmarks, recent vesting, the portfolio value of existing options, and employee rank. In addition, estimates of the cost of stock option grants that account for these factors are both statistically and economically different than cost estimates computed from commonly used models outlined in present regulatory guidance for financial reporting.
Strategic Disclosure of 10b5-1 Trading Plans
(with M. Todd Henderson and Karl Muller)
Abstract:
We investigate the potential for strategic disclosure regarding insiders’ Rule 10b5-1 trading plans. Theoretical research suggests that disclosing informed traders’ intent to trade is not strategically advantageous, but this theory does not account for litigation benefits from disclosure. Evidence indicates that 10b5-1 disclosure increases with firm litigation risk, with insider strategic trade potential, and with institutional owner and analyst disclosure demands. Evidence also indicates that 10b5-1 disclosure is associated with greater abnormal returns to insiders’ trades, especially for firms disclosing specific plan details. These findings indicate that legal risk can compel firms to depart from a non-disclosure strategy regarding insiders’ intent to trade, and that disclosure’s legal benefit might enhance strategic trade. Courts might infer from these findings that 10b5-1 participation does not inherently indicate lack of scienter. Regulators might also infer that a mandate to disclose 10b5-1 participation, by itself, may not mitigate strategic behavior since non-disclosing firm insiders appear less strategic.
The Impact of General Counsel on Insider Trading and Information Risk
(with David Larcker and Dan Taylor)
Abstract:
Most corporate governance research has focused on the behavior of chief executive officers, board members, institutional shareholders, and other similar parties. Little research has focused on the impact of executives whose primary responsibility is to enforce and shape corporate governance inside the firm. This study examines the role of the General Counsel in mitigating informed trading by corporate officers and associated information risk. We find that insiders’ trading profits and measures of information risk are generally higher when insiders trade within firm-imposed restricted trade windows around earnings announcements. However, when General Counsel approval is required to execute a trade within these windows, insiders’ trading profits and measures of information risk are substantively lower. Thus, when given the authority, it appears the General Counsel can effectively limit the extent to which officers use their private information to extract rents from shareholders.
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