Revisiting the Relation between Equity Incentives and Financial Misreporting: The Effect of Measurement Error in Delta.

• In Event: Equity Incentive, Financial Reporting, and Fair Value Accounting

Abstract

Armstrong et al. (2013) document a strong positive relation between the vega of managers’ equity portfolio and financial misreporting, and show that the effect of vega on misreporting subsumes that of delta. We hypothesize and find that their results are attributable to the measurement error in delta. Splitting the delta of managers’ equity portfolio into stock delta and option delta, we provide evidence that option delta has a dominating effect over vega in explaining the likelihood and extent of financial misstatements. Our findings contribute to the literature on executive compensations by revealing the differential effects of stock delta, option delta, and vega on providing managers with incentives for financial misreporting.

Authors

• Bo Xu, University of Massachusetts Boston

• Jay Junghun Lee, University of Massachusetts Boston