A new study finds that an underperforming stock and CEO compensation linked to option price can increase the chance of financial fraud. Steve Mirsky reports.
A business shocker—when management incentives consist mainly of stock options, there’s an increased likelihood of cooking the books to increase the stock price. That’s according to a study called Incentives to Cheat: The Influence of Executive Compensation and Firm Performance on Financial Misrepresentation, in the current issue of Organization Science. That’s a publication of the Institute for Operations Research and the Management Sciences.
The authors note that two factors substantially increase the likelihood of some fuzzy math to up the stock price: very low stock performance relative to the average performance of stocks in the same industry; and stock options making up high percentages of a CEO’s compensation. The researchers found that over a five year period there was a 9 percent chance that a company would misrepresent its financial situation—and be discovered. So actual misrepresentation is probably higher than 9 percent.
Bonuses didn’t have the same effect as options, which offer much greater opportunities for windfalls. With sometimes tens of millions of dollars on the line in stock options, the authors say, “that’s enough to motivate some executives to deliberately fudge the books.”