Managerial stock sales and earnings management during the 1990s stock market bubble

Stock-based compensation puts managers in the position of having, at some point, to sell stock. The prevalence of stock-based compensation in the 1990s allegedly created incentives for managers to hype their companies’ stock price by manipulating earnings before selling stock. Consistent with this conjecture, we find that managers tended to inflate earnings prior to selling stock. Moreover, the corrections individual stocks experienced after the 1990s market bubble burst are strongly negatively associated with the estimated levels of earnings management and insider selling during the bubble. On average, during the last years of the bubble, (i) the returns of firms that managed earnings the most are 24 percent higher than the returns of firms that managed earnings the least and (ii) the returns of firms where insiders sold the most stock are 88 percent higher than the returns of firms where insiders sold the least stock. Conversely, during the correction, (i) the returns of firms that managed earnings the most are 51 percent lower than the returns of firms that managed earnings the least and (ii) the returns of firms where insiders sold the most stock are 32 percent lower than the returns of firms where insiders sold the least stock. Overall, the evidence is consistent with the conjecture that high levels of stock-based compensation exacerbated stock price run-ups and subsequent corrections during the 1990s market bubble. Managerial stock sales and earnings management during the 1990s stock market bubble