Is there a trade-off between accrual-based and real earnings management? Evidence from equity compensation and market pricing

Abstract

Recent studies indicate a trade-off relation between accrual-based and real earnings management strategies. This paper studies the relation by examining the impact of the equity compensation of chief executive officers (CEOs) on earnings management and the market pricing of the two types of earnings management. Moreover, this study proposes a “within-group difference” approach for both the explained and explanatory variables to mitigate the over-parameter problem in the conventional fixed effects regression model for panel data. Our empirical results show that CEO equity compensation is positively associated with both accrual-based and real earnings management. Moreover, the reward of the joint effect of accrual-based and real earnings management is positive in terms of stock returns and stronger than a stand-alone strategy. Overall, our results indicate that the relation between accrual-based and real earnings management for firms is complementary rather than a trade-off.