Apart from that there is another type of risk which can surface even in case the market continues its upward march. In the event employees exercise their ESOPs in huge numbers, external shareholders could oppose the diluting impact of these option grants on the value of their shares. A situation might crop up that old possible tensions among employee interests and shareholder interests are not all of a sudden resolved by converting employees into shareholders. (Worker Capitalists: Giving Employees an Ownership Stake) Regardless of various shortcomings, stock options have come to assume a popular means for aligning managers and shareholders interests alike. Benefits from availing stock options gave 70% of median CEO total direct compensation, consisting of salary, bonus, restricted stock, gains from stock option exercise and long-term incentive payouts, and fix the upper limit for the remainder of the firm's compensation system. Adhering with the conventional doctrine of the agency theory, enhancements in CEO stock options, along with effective monitoring, generate sound alignment among the interests of management and shareholders. This implies that CEOs as well as shareholders profit from the spiraling stock prices in the long-term, thus lowering the chances of moral hazard. Besides, favorably valued stock options pose risk for the CEOs. The most important problem in case of corporate governance is not whether a particular agent has integrity or otherwise, a lot of honest CEOs possibly would act in the interests of the shareholders even when given substantial incentive and scope to do something on the contrary. (Do Stock Options prevent or promote fraudulent financial reporting)

Instead, the difficulty lies with the fact whether or not in the existence of a dishonest agent a specific control system will either (i) remove the dilemma by aligning the interests of all parties or (ii) evaluate the unprincipled agent strongly to guarantee that there will be no chance for the self-interested behavior to happen. Preferably as per the principal-agent theory, CEO stock options must remove the moral impasse by aligning CEO interests with those of the shareholders, even if they might not completely do so and thus persistent monitoring by the Board of Directors is essential. A perspective is offered that as against agency theory, stock options can in fact aggravate the ethical risk confronting CEOs by providing added incentive for self-interested behaviors. This implies that when there is a chance, ESOPs will raise the chances of vested behaviors by devious CEOs, affecting the shareholders in the long run. (Do Stock Options prevent or promote fraudulent financial reporting)

The light of argument is steady with research in accounting investigating the general hypothesis that compensation plans is able to encourage CEOs to make beneficial or also deceptive decisions. For instance, evidence was found by Barton in a sample of Fortune 500 firms that cash compensation was directly linked to the application of earnings management method, whereas the value of stock owned by the CEO and the number of options held by the CEO was linked with the interest rate and foreign currency derivatives. It was Barton who arrived at the decision during 2001 that managers were deliberately managing earnings to augment their cash compensation and applying derivatives to raise the value of their stock-based compensation. Also in a research of firms readying for an IPO, it was reported by DuCharme, Malatesta and Sefcik that managers doctored the earnings to raise the amount from the IPO at the cost of investors. (Do Stock Options prevent or promote fraudulent financial reporting)

It was demonstrated by Guidry, Leona and Rock during 1999 that earnings management is linked with CEO bonuses, whereas Healy found more that the bonus plan adoptions and alterations to bonus plans are linked with modifications in earnings management. It was proven by Hirst in 1994 that bonus plans make incentives in such a manner that their bonuses would be become the greatest. Besides, even though it was found by Gerety and Lehn during 1997 that no distinct association between the application of accounting-based management compensation plans, like profit sharing, bonuses or stock options, and cases of accounting swindles, they found out that large stockholdings by a sole executive lowered the chances of deception. Therefore the accounting literature gives proof that executives might arrive at company decisions that have been designed to raise their individual wealth at the maximum point. To put it differently, managers might 'engineer' the incentive system due to lack of information symmetry and act in ways that augment their own...

Hence the extent and value of CEO stock options is directly linked with the chances of fraudulent financial reporting. The power of the proposed competing relationship between the value of the CEO stock options and the occurrence of fraudulent financial reporting is possibly impacted by two more factors viz CEO duality and Board of Directors -- BOD stock compensation. (Do Stock Options prevent or promote fraudulent financial reporting)
In cases where the CEO also functions as the BOD chair, persistently has been identified as a disagreement of interest in corporate governance, as this is also seen as a pointer of CEO power. Even though members of the board are responsible with ruling the company and guaranteeing higher levels of company performance, they might be unsuccessful to perform effectively in the situation of CEO duality. In situations where the CEOs serve as the board chair, have the upper hand over the board member nominating process, the compensation-fixation process, agenda for discussion in the board and the like, even if they are not officially serving the committees charged with those responsibilities. This is a serious issue and might undermine corporate governance. Previous research has demonstrated that this duality is linked with higher executive compensation, poison-pill espousal, diversification and takeover premiums. This might be the consequence due to powerful CEOs who also happen to be board chairs bypassing the governance process in an endeavor to tailor the organization according to their preference. (Do Stock Options prevent or promote fraudulent financial reporting)

Therefore CEOs who also are Chairmen of their company's board will have higher power which in the process will render it easier for them to either (i) guarantee that the interest of the shareholders are most important in accordance with the agency theory or (ii) carry on their self-interest unhindered, under the unprincipled agent argument. Therefore CEO duality is suggested to augment the relationship whether positive or otherwise, between CEO stock options and inconsistencies of accounting methods. The common prescription of the principal-agent theory is based on the fact that granting CEO stock options raises their financial interest in the long-term share performance, thus matching the CEOs' interest with those of the shareholder and guaranteeing actions which will be advantageous on the part of the shareholders. However, the unprincipled view remains that the moment stock options becomes exercisable they extend an instant financial benefit for the CEOs and helps them to pump up near-term financial performance at the cost of long-term outcomes. Therefore, CEO stock option grants might in fact impair shareholders as they could resort to fraudulent financial reporting and a lowering in the long-term share performance. (Do Stock Options prevent or promote fraudulent financial reporting)

Mixed results were found as regards the principal-agent theory claim that rising CEO stock options can match interests of the CEO with those of the shareholders; proof of this happens in very restricted situations. It has been found that raising CEO stock options results in reduced chances of fraudulent financial reporting as prophesied by the agency theory only when (i) the CEO also happens to be the BOD chair and the BOD also has stock options or (ii) the CEO is not the BOD chairman and the BOD has no stock options. As against the principal-agent theory, it was deduced that raising CEO stock options results in a higher chance of fraudulent financial reporting in situation when (iii) the CEO is also the BOD Chairman and the BOD does not have any stock options and to a much higher chance of fraudulent financial reporting when (iv) the CEO is not BOD chair and the BOD has stock options. (Do Stock Options prevent or promote fraudulent financial reporting)

With the rise in CEO stock options, regardless of BOD possessing stock options, it has a rising influence on the chances of fraudulent financial reporting. Besides, this impact differs depending on whether or not the CEO is also the chairperson of the board. In situations when the CEO is not BOD chair and the BOD is devoid of any options, the chances of fraudulent financial reporting reduces to its lowest level for the sample with the rise in the CEO options. In this circumstances, the external chairperson and BOD members continue with their monitoring job and seem especially watchful as the CEO options rise, even without additional, agency-based "interest alignment" from their own stock options. In situations when the CEO is not also the BOD chair and BOD stock options are there,…