“Executive Pay, Earnings Manipulation and Shareholder Lawsuits” by Lin PENG
The City University of New York
The paper analyzes the relationship between executive compensation and shareholder class action litigation. Incentive pay in the form of bonuses and options is found to significantly increase the probability of such a lawsuit, holding constant a wide range of other firm characteristics. In contrast, base pay levels and restricted stock grants do not have a significant impact on lawsuit incidence. Firms whose executives hold restricted stock only, and no options, induce less shareholder litigation. We further examine whether earnings manipulation, as measured by estimated discretionary accruals, is an important channel for this phenomenon. Incentive pay does have a significant impact on our measure of earnings manipulation, which in turn does significantly affect the probability of litigation. However, our measure of manipulation does not capture the full impact of compensation on litigation, suggesting other channels are important.