Enron employees outside the company's Houston headquarters on December 3, 2001, the day after the company went bankrupt.
Photograph by David J. Phippip — AP
By David Z. Morris
January 26, 2017

Researchers from Arizona State University, Rutgers, and Columbia Business School have found that companies issue more stock options to employees when they’re falsifying financial statements. Because stock prices often tumble when a company is accused of deceiving investors, spreading options around gives employees an incentive to keep quiet. And the tactic, tracked through more than fifteen years of records, seems to work.

The study, published in The Journal of Accounting and Economics and summarized in the Harvard Business Review, surveyed records from 663 firms that faced litigation for financial misreporting between 1996 and 2011. It found that firms issued 14% more stock options during periods when they were alleged to have massaged financial results than companies not accused of wrongdoing. The rate of option issuance at the dirty companies also dropped 32% after episodes of fraud stopped.

Further, it looks like the tactic is actually effective in reducing whistleblowing. Companies in the study that were not reported by an insider granted 78% more options than companies that were exposed by whistleblowers.

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The researchers cast the tactic as a counterpart to the 2010 Dodd-Frank reforms, which established both protections and financial incentives for employees who disclose fraud.

The authors point out that their findings don’t directly link options to suppressed whistleblower activity -– as the old saw goes, correlation does not equal causation. They also emphasize that their data came only from companies who got caught, making it possible that companies who issued even more options never faced justice at all.

On the other hand, of all the companies in the dataset, only about 10% were targeted by whistleblowers, meaning it didn’t usually take an insider to spot fraud.

For more on corporate cons, watch our video.

Despite those caveats, the findings “suggest that firms may offer their own financial incentives to discourage whistleblowing.” While unscrupulous executives could read that as a tip for getting away with fraud, it’s just as likely to help canny investors spot trouble before they get burned.

 

 

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