Discretionary Accruals Models

While longer incentives are associated with higher persistence, especially for companies that have larger amounts of exercisable options, it is unclear whether companies that adopt smaller vesting + lockup periods in their compensation present less persistent earnings due to higher short-term manipulation or higher incentives for investing in projects that yield higher returns on the short run.

Table 8: Models on Persistence by 𝑳𝑻𝒊,𝒕 subsamples.

The table presents dynamic panel-data estimation based on a two-step system GMM. Only firms that adopt ESOP compose the sample. We divide the sample into two groups: firms that have incentive horizons (lockup + vesting period) longer than 5 years and those that do not.

𝑬𝒊,𝒕+𝟏 = 𝜶𝒐+ 𝜶𝟏𝑬𝒊,𝒕+ 𝜶𝟐𝑬𝒙𝑶𝒑𝒊,𝒕 + 𝒗𝒕+𝟏 (8) 𝑬_{𝒊,𝒕+𝟏}= 𝜶_𝒐+ 𝜸_𝟏𝑨𝑪_𝒊,𝒕+ 𝜸_𝟐𝑪𝑭_𝒊,𝒕+ 𝜸_𝟑𝑬𝒙𝑶𝒑_𝒊,𝒕+ 𝒗_𝒕+𝟏 (9)

Variables Groups by Long-term Dummy (5 years) 𝑳𝑻𝒊,𝒕 = 0 𝑳𝑻𝒊,𝒕 = 0 𝑳𝑻𝒊,𝒕 = 1 𝑳𝑻𝒊,𝒕 = 1

𝑬𝒊,𝒕 0.4563*** - 1.213* -

𝑨𝑪𝒊,𝒕 - 0.4937* - 1.0168*

𝑪𝑭𝒊,𝒕 - 0.4738* - 1.1572*

𝑬𝒙𝑶𝒑𝒊,𝒕 -0.3874*** -0.4609*** 1.0651** 0.6762**

Constant 0.0172* 0.012 -0.031** 0.0038

AR(1) Z= -1.52 Z= -0.93 Z= -1.27 Z= -1.63

AR(2) Z= -0.09 Z= -0.91 Z= 0.94 Z= 0.28

Sargan Test (Chi²) 61.45* 293.51* 0.13 9.89

Hansen Test (Chi²) 2.75 45.39 0.14 0.940

Dif-Hansen (Chi²) 1.32 45.00 0.00 0.963

Wald Test (Chi²) 36.50* 47.83* 1876.01* 94.66*

Obs. 368 368 59 59

Groups 67 67 16 16

Instruments 7 58 5 14

*Significant at 1%; ** Significant at 5%; *** significant at 10%.

AR(1) and AR(2) report the Arellano-Bond test for first and second order correlation between the error terms. The Sargan and Hansen Tests report whether instruments are exogenous. The Dif-Hansen statistics indicates whether the Systemic GMM is valid.

Source: Elaborated by the authors.

Overall, results in this section lead us to not reject H1 and H2, as companies that include long-term incentives (LT>5) present more persistent earnings and accruals. In the next section, we analyze how short-term contracts affect discretionary accruals, as discretionary accounting choices directly represent manipulations of accounting reports and possibly reduce earnings quality.

our persistence models that suggests that ESOP incentives should last longer than five years in order to affect EQ.

In all of the estimated models, controlx variables behave similarly, except for the Size of Sales, which positively affected discretionary accruals in the LT>2 and LT>3 models and negatively impacted abnormal accruals in the remaining specifications. However, as we observe that the LT>5 and LT>6 models present a better fit, we interpret that a higher Size of Sales is associated with smaller abnormal accruals. This finding is similar to what Lemma, et al. (2018) observe for American companies.

As expected, previous year discretionary accruals (𝑫𝑨_{𝒊,𝒕−𝟏}) has a negative impact on current year accruals. This is associated with accruals reversion (Kothari et al., 2016), and illustrates the necessity of controlling for endogeneity we have previously discussed (Barros et al., 2020). It is interesting to notice that accruals reversion confirms Peng and Röell’s statement that “in the long run the truth will come out, even if in the short run stock price can be manipulated” (Peng & Röell, 2014, p. 489).

Table 9: Model on Discretionary accruals.

The table presents dynamic panel-data estimation based on a two-step system GMM. All non-financial firms traded on B3 with available data are included in our sample.

We treat 𝐴𝐶_{𝑖,𝑡−1}, (𝛥𝑅𝐸𝑉_𝑡− 𝛥𝐴𝑅_𝑡) and 𝐸_𝑖,𝑡 as endogenous.

𝑨𝑪𝒊,𝒕 = 𝜷𝟎+ 𝝓𝒂𝒄𝑨𝑪𝒊,𝒕−𝟏+ 𝜷𝟏 𝟏 (𝑨𝑻𝒊,𝒕+𝑨𝑻𝒊,𝒕−𝟏

𝟐 ) +𝜷𝟐 (𝜟𝑹𝑬𝑽𝒕− 𝜟𝑨𝑹𝒕) + 𝜷_𝟑 𝑷𝑷𝑬𝒕+ 𝜷𝟒𝑬𝒊,𝒕+ 𝒗𝒊,𝒕 (𝟏𝟎)

𝐴𝐶𝑖,𝑡−1 0.279261*

𝑅𝑒𝑣𝑒𝑟𝑠𝑒 𝐴𝑠𝑠𝑒𝑡𝑠 (𝜷𝟐) 416487.2*

(𝛥𝑅𝐸𝑉_𝑡− 𝛥𝐴𝑅𝑡) -1.64155***

𝑃𝑃𝐸_𝑖,𝑡 -1.448913

𝐸_𝑖,𝑡 0.1684543*

𝐶𝑜𝑛𝑠𝑡𝑎𝑛𝑡 .0082766

AR(1) Z= -1.10

AR(2) Z= 1.02

Sargan Test (chi²) 0.18 Hansen Test (chi²) 4.29 Dif-Hansen Test (chi²) 3.70 Wald Test (chi²) X² = 10098.72*

Observarions 2097

Groups 222

Instruments 17

*Significant at 1%; ** Significant at 5%; *** significant at 10%.

AR(1) and AR(2) report the Arellano-Bond test for first and second order correlation between the error terms. The Sargan and Hansen Tests report whether instruments are exogenous. The Dif-Hansen statistics indicates whether the Systemic GMM is valid.

Source: Elaborated by the authors.

Another variable that has met theoretical expectations based on financial literature is Leverage. In all reported models, leverage has positively impacted discretionary accruals. The possibility of violating debt covenants play a decisive role on this relationship (Baker et al., 2003), because inflating earnings through EM can reduce the debt-to-asset ratio.

Board Independence negatively affects discretionary accruals in all models. This finding indicates that higher board independence reduces the probability that a manager might manipulate earnings upward through discretionary choices regarding accruals. Other than reducing positive accruals manipulation, Prencipe and Bar-Yosef (2011) find that independence also reduces the absolute value of discretionary accruals, which suggests that the monitoring

role of board independence reduces both positive and negative manipulation of accruals. While we do not estimate a model for the absolute value of 𝐷𝐴𝑖,𝑡, our results should be interpreted by assuming the possibility that the negative effect of independence on this variable might not be related to downwards earnings manipulation.

Regarding ESOP variables, in all 𝑫𝑨𝒊,𝒕 models a larger grant of options in the following year negatively affects discretionary accruals, corroborating H3. This is consistent with previous literature and shows that managers manipulate stock prices downward in a year that precedes large grants in order to decrease strike prices (Aboody & Kasznik, 2000; Baker et al., 2003). However, this finding is novel for the Brazilian context, and shows that even in an emerging market such managers utilize accounting discretion to reach their own goals. It should be noted that data on whether grants are scheduled or not are not widely available for Brazilian countries. Hence, we are unable to identify whether randomizing grants might alleviate downward manipulations prior to grants.

Table 10: Models on Discretionary Accruals – Equation 9

The table presents dynamic panel-data estimation based on a two-step system GMM. Only firms that adopt ESOP compose the sample.

We treat 𝐷𝐴_{𝑖,𝑡−1}, 𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒_𝑖,𝑡 and 𝑆𝑎𝑙𝑒𝑠_𝑖,𝑡 as endogenous.

𝐷𝐴_𝑖,𝑡= 𝛽_0𝑖+ 𝜙_𝑑𝑎𝐷𝐴_{𝑖,𝑡−1}+ 𝛽₁𝐺𝑟𝑂𝑝_𝑖,𝑡+1 + 𝛽₂𝐸𝑥𝑂𝑝_𝑖,𝑡+1 + 𝛽₃𝐿𝑇_𝑖,𝑡+1

+ 𝛽₄𝐸𝑥𝑂𝑝_𝑖,𝑡+1𝐿𝑇_𝑖,𝑡 + 𝛽₅𝐼𝑛𝑑𝑒𝑝𝑒𝑛𝑑𝑒𝑛𝑐𝑦_𝑖,𝑡+ 𝛽₆𝐿𝐸𝑉_{𝑖,𝑡−1} + 𝛽₇𝑙𝑛𝑆𝑎𝑙𝑒𝑠_𝑖,𝑡+ 𝛽₆𝐿𝐸𝑉_{𝑖,𝑡−1} 𝜀_𝑖,𝑡 (11)

Variables Long-term dummy specification (LT = Vesting + Lockup period) LT > 2 LT > 3 LT > 4 LT > 5 LT > 6

𝑫𝑨𝒊,𝒕−𝟏 -0.135** -0.138** -.06168 -0.1221*** -0.1168***

𝑳𝑻𝒊,𝒕+𝟏 0.1602 0.194 .17203 -0.1294 -0.3579**

𝑬𝒙𝑶𝒑𝒊,𝒕+𝟏 12.7669 -17.5904 -50.2273** -44.0423* -41.2352*

𝑬𝒙𝑶𝒑_{𝒊,𝒕+𝟏}𝑳𝑻_{𝒊,𝒕+𝟏} -51.6334 -22.81 22.9189 34.9004** 31.5129**

𝑮𝒓𝑶𝒑_{𝒊,𝒕+𝟏} -29.0987* -28.601* -27.0275* -25.2681* -26.1821*

𝑺𝒂𝒍𝒆𝒔_𝒊,𝒕 0.2324** 0.2569** -0.2076 -0.2534** -0.2603**

𝑳𝒆𝒗𝒆𝒓𝒂𝒈𝒆𝒊,𝒕 1.6462* 1.7195* 1.4448*** 1.7483* 1.7345*

𝑰𝒏𝒅𝒆𝒑𝒆𝒏𝒅𝒆𝒏𝒄𝒚𝒊,𝒕 (𝟏) -0.5871*** -0.6531*** -1.684*** -0.6560*** -0.7205**

Constant 2.8742*** 3.2139** 3.2737** 3.3124** 3.3945**

AR(1) Z= -5.02* Z= -4.91*** Z = -4.78* Z= -5.05* Z= -5.06*

AR(2) Z= -0.55 Z= 0.61 Z = 0.14 Z= -0.11 Z= -0.21

Sargan Test (Chi²) 101.86* 101.31* 96.56* 99.70* 101.49*

Hansen Test (Chi²) 39.57 40.27 39.50 41.46 40.43

Dif-Hansen (Chi²) 37.26 37.25 38.88 37.17 37.51

Wald Test (Chi²) 39.94* 32.98* 26.88* 29.25* 31.78*

Obs. 389 389 389 389 389

Groups 72 72 72 72 72

Instruments 41 55 39 42 42

*Significant at 1%; ** Significant at 5%; *** significant at 10%.

AR(1) and AR(2) report the Arellano-Bond test for first and second order correlation between the error terms. The Sargan and Hansen Tests report whether instruments are exogenous. The Dif-Hansen statistics indicates whether the Systemic GMM is valid.

(1) We have tested whether CEO/Board Chairman duality is a better proxy for corporate governance in the DA model, but this variable was not significant.

Source: Elaborated by the authors.

Contrary to our expectation stated in H4, 𝑬𝒙𝑶𝒑𝒊,𝒕+𝟏 negatively affects previous years discretionary accruals (𝑫𝑨_𝒊,𝒕). We assumed that the proximity to a large portion of options vesting period (or the end of lockups) would incite managers to manage earnings upward, but

our findings suggest that managers with short-term compensation might perform a big bath in the year that precedes a large vesting of options. This could explain why earnings are less persistent for these companies, as shown in section 4.1.

This finding is not consistent with the study of Bartov and Mohanram (2004), as they observe an increase in abnormal earnings in the period prior to the exercise of options, which reverses into bad performances in the following year. However, our result complements the findings of Bergstresser and Philippon (2006), as they observe that earnings management is higher in periods on which a higher number of options exercise occurs. Hence, managers might manipulate earnings downward in the prior year and upwards when options are exercisable.

This tactic allows managers to hold good news for the following year.

The finding on 𝑬𝒙𝑶𝒑_{𝒊,𝒕+𝟏} also nullifies our fifth hypothesis (H5), which states that the positive effect of the level of 𝑬𝒙𝑶𝒑_{𝒊,𝒕+𝟏} on 𝑫𝑨_𝒊,𝒕would be smaller for companies that adopt long-term contracts. However, it is interesting to notice that the negative effect of

𝑬𝒙𝑶𝒑_𝒊,𝒕on 𝑫𝑨_𝒊,𝒕is indeed smaller for companies that adopt long-term incentives (LT>5). This suggests that, by incentivizing long-term oriented decisions, contracts that last longer than five years seem to reduce incentives for accruals manipulation. This finding is consistent with theoretical arguments that including longer incentives in contracts lead managers to waste less effort and time on manipulations that relate to short-term incentives (Peng, & Röell, 2014). It also corroborates empirical evidence on the positive effect of shorter-duration executive compensation on incentives for short-term performance manipulation (Gopalan et al., 2014).