CEO compensation and accruals management

Abstract

This paper aims to investigate whether the boards curb earnings management by revising the compensation contract with CEOs. Using a sample of CEO compensation from 1993 to 2009, we find that the boards decrease cash payment sensitivity to accruals in the presence of the horizon problem. However, in the mean time, the boards heighten equity payment sensitivity to accruals and keep the total pay for performance sensitivity unchanged. We argue this temporary equity rewards for discretionary accruals will disappear as the value of equity claims will be realised over time and any market overpricing will evaporate by then. Overall, our results suggest that the boards can curb earnings management by revising pay-for-performance sensitivity in the terminal year.