Equity incentives, earnings management and corporate governance: Empirical evidence using UK panel data

Download This Article

This work is licensed under a Creative Commons Attribution 4.0 International License.

Abstract

Using a UK panel data set drawn from 1675 Chief Executive Officer (CEO) year observations and 1540 Chief Financial Officer (CFO) year observations, we examine the relationship between CEO and CFO equity incentives and earnings management. In addition, we examine the moderation effect of corporate governance mechanisms on the relationship between executives’ equity incentives and earnings management. We use multivariate regression models to test our hypotheses. We find that CEO equity incentives are related to higher absolute and income increasing earnings management. These results support the managerial power theory argument that CEOs exploit equity-linked compensation to obtain more personal benefits without causing public anger. Contrary to CEO equity incentives, we could not find any significant relationship between CFO equity incentives and any of the earnings management proxies. In addition, we find that corporate governance quality (measured by individual mechanisms and overall index) has no effect on the relationship between executives’ equity incentives and earnings management. This result indicates that whereas some corporate governance mechanisms can reduce earnings management in general, they do not affect wealth driven incentives to manipulate accruals. In total, results question the effectiveness of the corporate governance system in mitigating opportunistic behavior motivated by executives’ compensation structures.

Keywords: Discretionary Accruals, Executive Compensation, Corporate Governance, Agency Theory, Managerial Power Theory

Authors’ individual contribution: Conceptualization – M.A.S.A. and A.H.A.; Methodology – M.A.S.A. and H.R.I.; Software – M.A.S.A. and H.R.I.; Validation – H.R.I. and A.H.A.; Formal Analysis – M.A.S.A.; Investigation – A.H.A.; Resources – M.A.S.A.; Data Curation – M.A.S.A., H.R.I., and A.H.A.; Writing - Original Draft – M.A.S.A.; Writing - Review and Editing – H.R.I. and A.H.A.; Visualization – M.A.S.A.; Supervision – A.H.A.; Project Administration – M.A.S.A. and H.R.I.; Funding Acquisition – M.A.S.A.

JEL Classification: G340, M210, M410, M420, M480

Received: 24.09.2019
Accepted: 30.01.2020
Published online: 31.01.2020

How to cite this paper: Shabeeb Ali, M. A., & Ismael, H. R., & Ahmed, A. H. (2020). Equity incentives, earnings management and corporate governance: Empirical evidence using UK panel data. Corporate Ownership & Control, 17(2), 104-123. https://doi.org/10.22495/cocv17i2art10