How do accounting practices spread? An examination of law firm networks and stock option backdating

• Main Authors: TAN, Teck Meng Junior, DECHOW, Patricia M.
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2017
• Subjects: accounting practices; stock options; backdating; law firms; directors; geographic location; network analysis; Accounting; Accounting Law
• Online Access: https://ink.library.smu.edu.sg/soa_research/1724; https://ink.library.smu.edu.sg/context/soa_research/article/2751/viewcontent/SSRN_id2688434.pdf
• Institution: Singapore Management University

We hypothesize that one way that accounting practices spread is through law firm connections. We investigate this prediction by examining companies that avoided reporting compensation expense by engaging in stock option backdating. We hypothesize that executives engaged in backdating because they were desensitized to its inappropriateness when they learned through their legal counsel that other companies were engaging in this practice. We identify backdating companies through backdating-related restatements of earnings. Using network analysis, we document that backdating companies are more highly connected with other backdating companies via shared law firms. Logistic regressions indicate that the odds of a company backdating are 53 to 88 percent higher when its law firm has another client that backdates. We find that sharing a law firm is incremental to the impact of board interlocks and geographic location for explaining backdating. Finally, we document that law firms that have more clients that restate earnings due to backdating also have more other clients that are "lucky" (grant options at low prices). This suggests that other client companies also engaged in backdating but were not required to restate. Our evidence is consistent with law firms acting as "system supporters" in enabling executives to engage in backdating.