The Dynamic Relation Between the Structure of Compensation and Earnings Management

This study examines the relation between the form and the extent of earnings management and compensation and the potential endogeneity between them. The results indicate that the structure of compensation is a significant determinant of the extent and form of earnings management. The evidence is consistent with managerial opportunism since I find that managers smooth more (less) income as the proportion of bonus (stock-based compensation) increases (decreases) in the structure of compensation. Also, the results show that CEOs have incentives to manage earnings in order to maximize their bonus- and stock-based compensation. This result indicates that earnings management behavior and compensation are dynamic and suggests the necessity to consider their endogenous nature in examining their relationship.