∗This paper is an updated version of a previous working paper, “The Positive Role of Overconfidence and

The paper examines the role of executive compensation in inducing management behavior that triggers private securities litigation. Incentive pay in the form of options is found to increase the probability of securities class action lawsuits, holding constant a wide range of other firm characteristics. In contrast, base pay levels and share ownership do not have a significant impact on lawsuit incidence. Our results suggest that option-based compensation may give executives too strong an incentive to target the short term share price, which may be harmful to long term shareholder value. We further identify earnings manipulation as an important channel linking compensation and litigation: incentive pay has a significant impact on earnings manipulation, which in turn significantly affects the probability of litigation. However, our accrual-based measure of manipulation does not capture the full impact of compensation on litigation, suggesting other channels are important.

Abstract. We provide a method for modelling accounting distortions and their impact on the value of corporate liabilities. Our model is able to account for both small noise (estimate errors) and large mis-representations (deliberate fraud). Such a methodology is then applied to structural pricing models, in the spirit of Merton (1974). It turns out that accounting distortions may be a relevant factor in the pricing of corporate securities: indeed, they are able to explain why credit spreads are actually larger than implied by traditional structural models, particularly on short maturities. Simulations show that such an effect is stronger for safer firms, namely those with lower leverage and asset volatility.

A�������. The present paper investigates the role of product market competition in shaping incentive contracts and its effect on fraudulent behavior. We consider a framework where a manager, having private information about the company’s market share, can influence the company’s short-run market value exerting effort or through costly (fraudulent) signalling. We derive the optimal stock-based compensation contract which maximizes the expected long-run firm value in the presence of an imperfect monitoring technology and describe the shareholders trade-off between effort and fraud as the degree of product market competition varies. K�������: executive compensation, fraud, incentives, product market competition

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