Does peer firm executive compensation affect earnings management?

Abstract

PurposeThe purpose of this paper is to examine the relation between executive compensation of peer firms and earnings management. Given the prevalence of the competitive benchmarking practice in executive compensation, chief executive officer (CEO) compensation of potential peer firms can influence the behavior of CEOs at their current firms.Design/methodology/approachThis paper employs an ordinary least squares regression model to test whether CEO compensation of other firms in similar product markets is associated with a firm’s accruals management. It also employs firm fixed effects regressions to control for time invariant omitted variables. Lastly, it conducts subsample analyses based on CEO duality and the passage of Sarbanes-Oxley Act (SOX) and a propensity score matching analysis.FindingsUsing time-varying industry classifications based on product similarity, the author finds that CEO compensation of other firms in similar product markets is positively associated with a firm’s accruals management. The relation is more pronounced for firms with CEO duality, while it is less pronounced in the period after the passage of SOX. The main findings are robust to the use of firm fixed effects regressions, a propensity score matching analysis, and an alternative weighting scheme.Originality/valueThis paper contributes to the literature on executive compensation and earnings management. It provides useful insight into the spillover effect of other firms’ executive compensation on earnings management.