We examine the effect of executive compensation on earnings smoothing through research and development expenditures (R&D smoothing). We find that CEO risk-taking incentives derived from stock options significantly reduce R&D smoothing. This effect becomes more pronounced following the adoption of Financial Accounting Standard (FAS) 123(R), which mandated the expensing of stock options and curtailed their use for financial reporting purposes. Moreover, these risk-taking incentives are less effective in mitigating R&D smoothing among newly appointed or inexperienced CEOs, as well as among firms experiencing extreme losses. Overall, our findings underscore a positive role for CEOs’ option-based compensation in shaping managerial R&D investment decisions: by incentivizing risk-taking, such compensation discourages R&D smoothing and better aligns managerial actions with shareholders’ long-term interests.
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Chen et al. (2026) studied this question.
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