Jennifer J. Gaver

Additional evidence on the association between the investment opportunity set and corporate financing, dividend, and compensation policies

Abstract This paper presents additional evidence on the relation between the investment opportunity set and financing, dividend, and compensation policies. Our results are based on a sample of 237 growth firms and 237 nongrowth firms. We find that growth firms have significantly lower debt/equity ratios and exhibit significantly lower dividend yields than nongrowth firms. We also find that growth firms pay significantly higher levels of cash compensation to their executives and have a significantly higher incidence of stock option plans than nongrowth firms. However, controlling for firm size, the incidence of bonus plans, performance plans, and restricted stock plans does not differ between growth and nongrowth samples.

Additional evidence on bonus plans and income management

Abstract We extend Healy (1985) by examining the relation between discretionary accruals and bonus plan bounds for a sample of 102 firms for the 1980–1990 period. Contrary to Healy, we find that when earnings before discretionary accruals fall below the lower bound, managers select income- increasing discretionary accruals (and vice versa). We believe that our results are more consistent with the income smoothing hypothesis than with Healys bonus hypothesis. However, mechanical selection bias in portfolio formation cannot be entirely ruled out as an alternative explanation for our results.

Compensation Policy and the Investment Opportunity Set

We analyze the proportions of executive pay derived from salary, bonus, long-term incentive compensation, and stock-based compensation for a sample of 321 Fortune 1,000 firms in 1992. We find that firms with abundant investment opportunities pay higher levels of total compensation to their executives. Executives of growth firms receive a larger portion of their compensation from long-term incentive compensation (such as performance awards, restricted stock grants, and stock option grants), while those of non-growth firms receive a larger portion of their pay from fixed salary. An implication is that long-term incentives contracts reduce agency costs associated with manager-shareholder information asymmetries in growth firms.

Simultaneous Estimation of the Supply and Demand of Differentiated Audits: Evidence from the Municipal Audit Market

*University of Georgia. We wish to thank Linda Bamber, Michael Bamber, and Randal Elder for their helpful comments on an earlier draft of this paper. We also acknowledge the constructive suggestions of an anonymous referee. 1 Studies that investigate the supply-side determinants of audit fees include Palmrose [1986], Francis and Stokes [1986], Francis and Simon [1987], and Simon and Francis [1988]. Studies that investigate the demand-side determinants of auditor choice include Eichenseher and Shields [1986], Francis and Wilson [1988], Palmrose [1984], Rubin [1992], and Simunic and Stein [1987]. Some recent attempts to estimate supply and demand equations simultaneously include Banker, Cooper, and Potter [1992], Copley, Doucet, and Gaver [1994], and Deis and Giroux [1995]. Gaver and Gaver [1995] provide an analytical framework for simultaneous estimation of the supply and demand for multiattribute audits.

Earnings management under changing regulatory regimes: state accreditation in the insurance industry

Abstract As discussed in our paper, state oversight of the insurance industry became the subject of intense congressional criticism as insurance firm failures escalated in the late 1980s. In particular, claims of possible manipulation of loss reserves were alledged. In response to these criticisms, the National Association of Insurance Commissioners instituted a program for accrediting states that met certain standards aimed at improving the quality of the financial statement information reported by insurers domiciled within their borders. Our study investigates the association between the timing of state accreditation and the loss reserving practices of financially struggling insurers in the property-casualty industry. The results suggest that under-reserving by financially weak insurers declined in the post-accreditation period. This relation is apparent even after controlling for other influences on the reserve choice, such as tax goals and exogenous time-dependent effects. An interpretation is that improvements in insurer solvency monitoring related to accreditation are associated with a decrease in insurers’ proclivities to use accounting discretion to circumvent regulatory oversight.

Incentive Effects and Managerial Compensation Contracts: A Study of Performance Plan Adoptions:

This study examines the relation between manager-shareholder agency costs and the decision to adopt a long-term performance plan. It is argued that firms with mature investment opportunity sets adopt performance plans to equate manager-shareholder planning horizons. It is also argued that firms undergoing strategic change adopt plans to reduce managerial exposure to risk. Logit analysis on a sample of 81 performance plan adoptions and a random sample of 78 nonadoptions indicates that firms with stagnant investment opportunity sets and firms undergoing strategic change tend to be performance plan adopters. There is also evidence that performance plan adopters have a higher incidence of lapsed stock option plans than nonadopters. Overall, the results indicate that there are systematic differences between performance plan adopters and non-adopters which appear to be related to the manager-shareholder agency problems faced by the firm.

Simultaneous estimation of the demand and supply of differentiated audits

This study shows how the supply and demand for auditing services is analyzed in a simultaneous equations framework. An important aspect of the analysis is the assumption that an audit is a differentiated product that is valued for its productive attributes. A hedonic (multiattribute), nonlinear fee function defines the fees that clear the market for all audit packages traded. Analysis of marginal fees and quantities of audit attributes transacted requires simultaneous estimation of a supply and demand function for each attribute. Several approaches for estimating the hedonic fee function and achieving parameter identification in the underlying structural equations are suggested.

Discussion—Stock Option Compensation and Earnings Management Incentives

In “Stock Option Compensation and Earnings Management Incentives,” Professors Baker, Collins, and Reitenga ask whether managers manipulate discretionary accruals to reduce earnings prior to stock option awards. They reason that lower earnings translate into a lower stock price, which in turn reduces the exercise price of the options and increases their value. Further, recording lower discretionary accruals prior to the option grant defers positive accruals to the period following the grant. The authors recognize that managers have competing incentives to increase earnings to maximize the value of bonus awards and previous stock option grants. They therefore predict that the use of negative discretionary accruals will increase with the proportion of stock option awards relative to other compensation elements. To test their theory, Professor Baker and his colleagues collect compensation and earnings data from 1992 to 1998 for 168 firms. They obtain compensation data from three sources: Wall Street Journal compensation surveys, Execucomp, and proxy statements. They take earnings and discretionary accrual data from Compustat, and identify earnings announcement dates using the Wall Street Journal. The authors regress Jones (1991) model discretionary accruals on scaled option grants and an ensemble of control variables. To estimate this model, the researchers partition their sample according to the relation between premanaged and target earnings. If premanaged earnings exceeds target earnings, the manager faces pressure to decrease earnings, and vice versa. In general, the results indicate that in years when executives receive a high proportion of stock option compensation, discretionary accruals tend to be negative. This effect is strongest when an earnings announcement occurs in the two months prior to the option grant.

Financial Reporting Choices of Large Private Firms

We perform the first study of the fundamental financial reporting choices – audit, auditor, accounting standard, internal controls audit – of private funds (e.g., private equity, hedge funds, etc.), which represent an increasingly important component of the economy. We find that nearly 80% of private funds that are not subject to mandatory audit requirements obtain audits voluntarily. Larger, older funds with more owners and a higher level of sophisticated ownership are more likely to obtain audits, while funds with a higher level of inside ownership are less likely to obtain audits. Many of these characteristics are also associated with the likelihood of funds engaging a Big 4 auditor, obtaining an internal controls audit, and preparing GAAP financial statements. The growth and creation (termination) of private funds is positively (negatively) associated with funds’ preparation of GAAP financial statements or engagement of Big 4 auditors, providing new evidence on the value of financial reporting in the capital formation process. Overall, our evidence suggests that high-quality financial reporting aids private funds’ capital formation and that funds’ agency costs and the information needs of their equity investors influence funds’ financial reporting choices.