Hopwood, William S.

My objective is to evaluate whether managers, when executive stock options (ESOs) are part of their compensation, manipulate earnings by using discretionary accruals (DAs). Earnings manipulation requires managers to have some targets or expectations in mind. The target may be in the form of investors' expectations or the managers' own subjective expectations. Although meeting investors' expectations could result in income smoothing, executives might also manipulate earnings to achieve their own subjective expectations for private gains. I develop and test three hypotheses using logistic regression to address the issue of earnings manipulation by executives. The first hypothesis evaluates the likelihood of income smoothing when in-the-money ESOs (RVESO) are exercisable. RVESO represents the total value of exercisable ESOs in-the-money for the top five executives as disclosed in the proxy statement. The second hypothesis addresses the likelihood of earnings manipulation when a substantial dollar value of in-the-money ESOs are exercisable. The third hypothesis uses prior-period DAs to consider the possible effect of the value realized from exercise of ESOs on earnings manipulation. The empirical results of this study provide evidence that executives are not more likely to manipulate earnings when ESOs are part of the compensation package. Results indicate that an increase in the value of the RVESO does not increase the likelihood that management will use DAs to smooth income or manipulate earnings. One explanation of these findings could be that managers have some restraints on their actions that includes, but are not limited to, the presence of audit committees, vigilance by external auditors, the existence of an efficient labor market, and financial institutions that hold a sizable percentage of equity. Dechow, Sloan, and Sweeney (1996) state that fear of exposure and consequent penalty by the stock market is another constraint on managerial actions.

This study investigates the market valuation of the effect of goodwill tax amortization on corporate acquisitions. Specifically, the study tests whether a significant positive change exists in the market reaction to acquisitions qualifying for the Internal Revenue Code section 197. Two methodologies are employed in the examination of the market assessment of the effect of the Internal Revenue Code section 197. First, a market model methodology is utilized in order to pre examine whether the market reacted differently to acquisitions that qualified for goodwill tax deductibility relative to acquisitions that did not. Second, multiple regression models were obtained for testing the study's hypotheses. The results of this study support the hypothesis that a positive change exists in the market reaction to acquisitions that qualify for the internal revenue code 197 relative to those that do not. There are two implications for these findings. First, they imply that acquiring firms did retain some of the tax benefits associated with the change in the tax law. Second, and given the findings of previous studies, the findings of this study also imply that the expected tax savings are actually shared between the acquiring firm and the target's shareholders.

Dechow and Sloan [1991] investigate the hypothesis that CEOs, during their final years of office (the "horizon" years), manage discretionary expenditures to improve short-term earnings performance. Using a sample of 261 firm-years, this study extends the Dechow and Sloan model by including additional control variables. It also examines whether the discretionary components of earnings (discretionary accruals, discretionary revenue, and capital expenditures) provide departing CEOs a monetary incentive (bonuses) to manipulate these income factors. The general results of this study do not support the hypothesis that departing CEOs have a greater monetary incentive than incumbent CEOs to manage discretionary earnings to maximize their bonus schemes. A possible reason this hypothesis is not supported may be due to the fact that previous research has treated incumbent and departing CEOs as separate, homogeneous samples a treatment that the extant income-smoothing and CEO turnover research suggests may be flawed. Income smoothing literature provides evidence that some incumbent CEOs manipulate earnings to a predetermined target to avoid a "ratcheting" of expectations while CEO turnover research suggests that the "relay" process mitigates some departing CEOs' manipulations of earnings. Since agency theory predicts that management of accounting earnings will vary between groups of incumbent and departing CEOs, as well as within these two groups, the present study partitions the sample on the median change in operating cash flows for departing CEOs. This study finds evidence that departing CEOs in the above-median partition do increase income-enhancing discretionary accruals in their final year with the firm, and they have a significant economic incentive to do so. However, there is apparently no economic incentive for departing CEOs with an above-median change in operating cash flows to reduce discretionary revenue or capital expenditures.