Essays on managerial discretion

Abstract

"This thesis examines discretionary managerial decisions and investigates their association with the behavioral biases of market participants. We study managerial discretion in the context of repricing employee stock options (ESOs), audit opinion shopping, and misclassifying items in the financial statements. ESO repricing helps realign employee incentives and reduce executive turnover. However, option repricing critics regard repricing as a sign of managerial entrenchment and contributing to executives’ self-dealing behavior at the cost of shareholders’ interests. Our first essay investigates the US firms’ tendency to engage in repricing activity depending on the temporal shifts in firm-specific investor attention and market-wide investor sentiment. The results indicate a positive influence of investor distraction and a negative impact of investor sentiment on firms’ stock options repricing likelihood. With the temporary loosening of monitoring constraints due to the distraction of their institutional shareholders, top executives in a firm are more likely to reprice their stock options to maximize private benefits. Our second essay studies the managerial decision to switch or retain their auditor depending on the likelihood of receiving a clean audit opinion from the successor audit firm. We examine US firms’ audit opinion shopping activities and their association with temporal shifts in firm-specific investor attention and market-wide sentiment, including investor and managerial sentiment. We focus our analysis on two types of audit opinions, going concern and material weakness in internal controls audit opinion. Our results suggest a positive association between firms’ going concern-opinion shopping tendencies and the prevailing market-wide investor sentiment. Our findings are consistent with a lower cost of opinion shopping and weak shareholder monitoring in a high investor sentiment period (Amin et al. 2021). Our investigation also indicates a positive influence of market-wide managerial sentiment on firms’ audit opinion shopping activities. Contrary to investor and managerial sentiment, we find no significant relation between firm-specific investor attention and firms’ opinion shopping activity. Finally, our third essay studies US firms’ tendency to misclassify their core expenses as negative special items and estimates its relationship with firm-specific investor attention and market-wide sentiment. Our findings indicate a negative influence of investor sentiment and a positive impact of market-wide executive sentiment on firms’ classification shifting activity. Our evidence is driven by managers’ forced turnover being less sensitive to poor firm performance in a high investor sentiment phase (Si et al. 2020). Our findings are also consistent with optimistic managers having unrealistic expectations about their firms’ future performance and may pursue to achieve those by reporting higher earnings in the short term (Hsieh et al. 2014). We fail to find evidence to confirm a significant association between classification shifting and prevailing firm-specific investor attention. In addition to the empirical contributions, our research has important implications for the investors, regulators, and audit committees, significantly when auditor independence is compromised."