Pay disparities within top management teams and earning management

Abstract

I examine the impact of pay disparity between the chief executive officer (CEO) and the next layer of executives in the top management team (TMT) on earnings management through real activities manipulation (RAM). I find that firms with larger pay disparities in the TMT exhibit more RAM and that the positive relation is driven by short-term compensation. The main findings are robust to corrections for endogeneity of all managerial incentive measures. I find some evidence that the positive relation between pay disparity and RAM is less pronounced for firms in homogeneous industries, while it is more pronounced for firms with CEO turnover in subsequent years. I also find that large pay disparity is associated with low future performance. Collectively, my evidence suggests that TMT pay disparity increases RAM by fostering extreme competition for advancement to the CEO position. This study provides useful insight into the distribution of executive pay and its effects on corporate earnings management behavior.