Abtract We provide evidence that the use of discretionary accruals to manipulate reported earnings is more pronounced at firms where the CEO's potential total compensation is more closely tied to the value of stock and option holdings. In addition, during years of high accruals, CEOs exercise unusually large numbers of options and CEOs and other insiders sell large quantities of shares.

Managers appear to manipulate firm earnings through their characterizations of pension assets to capital markets and alter investment decisions to justify, and capitalize on, these manipulations. Managers are more aggressive with assumed long-term rates of return when their assumptions have a greater impact on reported earnings. Firms use higher assumed rates of return when they prepare to acquire other firms, when they are near critical earnings thresholds, and when their managers exercise stock options. Changes in assumed returns, in turn, influence pension plan asset allocations. Instrumental variables analysis indicates that 25 basis point increases in assumed rates are associated with 5 percent increases in equity allocations.