The dynamic relation between CEOs compensation and earnings management

This study empirically examines both the form and the extent of earnings management and the possible endogeneity between earnings management and compensation. The results of the tests indicate that the total and mix of compensation are significant determinants of the extent and form of compensation. The evidence is consistent with managerial opportunism as managers smooth more (less) income as the bonus mix (stock-based compensation) increases (decreases). Also, the results provide strong evidence that CEOs have incentives to manage earnings to increase their total compensation and to maximize their bonus-based and stock-based compensation. This result provides an indication that earnings management behavior and compensation are dynamic and suggest the necessity to consider their endogenous nature in examining their relationship. The findings of this study should contribute to the academic research related to earnings management, compensation, and the usefulness of accounting numbers. Furthermore, the extent and form of earnings management related to compensation is important to accounting standard setters, regulators, investors, analysts, practitioners, and researchers because of the ongoing concern over earnings management.