Effects of the anti-hedging policy on income smoothing and managerial wealth diversification

Abstract

To enhance the alignment of shareholders and managers, companies have been increasingly adopting the anti-hedging policy that prevents managers from hedging their equity incentives. Using the propensity score-matched sample, we find that managers mitigate the effect of the anti-hedging policy on the risk of their equity incentive by smoothing reported earnings and selling their equity for diversification. We find insignificant changes in earnings informativeness, corporate risk-taking, financial misreporting, real activity manipulation, and CEO annual pay components following anti-hedging policy adoptions. Our findings provide implications on the incentive alignment effects of stock-based compensation contracts with anti-hedging provisions.