Executive stock options and earnings management: is there an option level dependence?

Purpose – This aim of this paper is to check whether the incentive role of executive stock options (ESO) depends on their level. Design/methodology/approach – The study is based on data from a sample of 538 American firms over 11 years (1994 to 2004). Using regression analysis, the degree of association between earnings management and the percentage stock options in total compensation for different levels of the stock options granted is determined. Findings – The study finds that ESO decreases the earning management and represents an additional control mechanism. When considering the level of ESO, a long‐term alignment of interests is found at low levels. However, at high levels, ESO becomes an additional source of agency conflict in the short and long runs. Research limitations/implications – The results confirm the coexistence of both the contractual and the managerial power hypotheses. Practical implications – This study suggests that the executive compensation strategy and particularly its stock option component should be reviewed. Originality/value – This study contributes to previous research by underlining the incentive impact of the level of stock options on the role of further incentive compensation.