Equity Incentives, Earnings Management and Insider Trading: An Empirical Investigation of the Agency Costs of Overvalued Equity

Abstract

This study investigates the empirical implications of the agency theory of overvalued equity(Jensen, 2005). It finds that after controlling for other earnings management incentives, firms with overvalued equity have larger abnormal accruals than non-overvalued firms. Besides, equity incentives provided for managers of overvalued firms exacerbate opportunistic earnings management. I also find that managers with higher equity incentives or undertaking more aggressive earnings management are more likely to take large share selling in the following year and that effects are more pronounced for overvalued firms. This study provides empirical support for the agency theory of overvalued equity (Jensen, 2005), as Jensen said, "Equity-based compensation cannot solve the problem because it makes the problem worse, not better (for overvalued firms)".