Abstract
This paper empirically studies the connection between earnings management and corporate social performance, conditional on the existence of CSR-contingent executive compensation contracts, an emerging practice to link executive compensation to corporate social performance. We find that executives are more likely to manipulate earnings to achieve their personal compensation goals when CSR rating is low, as well as their CSR-contingent compensation. Because of public pressure on their excessive total compensation, corporate executives see no need to manipulate earnings to increase compensation when their CSR-contingent compensation is already high. Our results suggest that earnings management and CSR-contingent compensation are substitute tools to serve the interests of executives, which is an agency problem that was never previously studied. Additionally, we explore how managerial characteristics affect earnings management, driven by the incentive effects of CSR-linked compensation.
Highlights
Because of the recent, tremendous social and political pressure on exaggerated executive compensation, many tools that corporate top executives can use to increase their compensation changed from complement to substitute
corporate social responsibility (CSR) contracting is a useful method to deter earnings management. These results suggest that, when executives can receive rewards through their CSR contracts by improving CSR rating, they are less likely to manipulate earnings; otherwise, their excessive compensation will be under public scrutiny
We embarked to discover if any links exist between the use of CSR-contingent compensation contracts and the use of earnings management to feign firm performance
Summary
Tremendous social and political pressure on exaggerated executive compensation, many tools that corporate top executives can use to increase their compensation changed from complement to substitute. That is, they can use one or some tools in their tool kit to achieve their personal compensation goals but refrain from using all their tools to earn excessive pay. Public pressure puts an implicit pay cap on their total annual compensation. The literature (e.g., References [1,2]) discovered political and labor union pressure on CEO compensation; Mohan, Schlager, Deshpandé, and Norton [3] found that consumers avoid buying from firms with higher CEO-to-worker pay ratios. Among all the tools that managers can apply to achieve their compensation target, an emerging practice for firms to link compensation to corporate social responsibility (CSR) performance, called CSR-contingent compensation, is a new tool that managers can use to increase pay, in addition to the traditional ones such as earnings management
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