Earnings Management and Executive Compensation: A Study of the Indian Manufacturing Sector

Abstract

Click Here:Access Full Text

We examine whether executive compensation influences the earnings management activities in a firm. Earnings management is broadly classified as accrual management and real earnings management. Information asymmetry between managers and shareholders provides the incentive to the former to manage earnings for their personal benefits. We find that a higher compensation ratio reduces accrual management (discretionary accruals) and real earnings management, which contradict the findings of Shuto (2007), and Adut et al. (2013). This show that managerial compensation improves the earnings quality of firms. The information asymmetry hypothesis is evident in firms, wherein increasing firm performance increases tax accruals that reduce firm value. The study identifies the threshold limits of earnings management with different levels of executive compensation by classifying the data into full sample and sub sample (overvalued and undervalued firms). Undervalued firms tend to have higher executive compensation as the level of earnings management (discretionary accruals and real earnings management) increases first to mimic the reporting strategies of overvalued firms and then subsequently as a tax planning strategy to improve firm value.

Keywords: Earnings Management, Executive Compensation, Discretionary Accruals, Earnings Smoothing, Real Earnings Management

View PDF