Keeping them honest? Broad-based employee ownership and earnings management

Abstract

Research Question/Issue

Does broad-based employee ownership limit accrual earnings management?

Research Findings/Insights

I run a series of random effect and fixed effect models on a sample of S&P 1500 firms between 2008 and 2019 to show that managers at employee-owned firms manipulate earnings less than managers at nonemployee-owned firms. My findings suggest that employee ownership enhances financial transparency and limits the opportunities for managers to misrepresent firm performance.

Theoretical/Academic Implications

This study develops and tests theory on employee ownership as a form of internal corporate governance. Equity incentives for executives are typically thought to reduce agency costs. The findings here suggest awarding equity incentives broadly, in which the majority of employees receive equity stakes, may be a more effective method of reducing agency costs.

Practitioner/Policy Implications

Earnings management and intentional financial misreporting are often a result of siloed information within firms. Broad-based employee ownership is generally associated with enhanced information flows through greater mutual monitoring and information sharing. Corporate governors interested in reducing managerial malfeasance may find that widely awarding equity to employees is more effective than financially incentivizing individual managers to act in the firm's interests.