Abstract
We examine whether the board of directors adjusts the sensitivity of CEO compensation to earnings following an earnings restatement. Using a sample of 598 restating firms and 2,065 non-restating firms during the period of 1995-2011, we find that firms decrease the sensitivity of cash compensation to accounting earnings after restatements and that this decrease is more pronounced for firms that appoint new CEOs after restatements than those whose CEOs continue to remain in office after restatements. Furthermore, the results suggest that the decrease in the sensitivity of cash compensation to earnings for restating firms with new CEOs is more pronounced for firms with a higher level of institutional ownership. This highlights the monitoring role of institutional investors in the redesign of compensation contracts following restatements. Overall, our results are consistent with the argument that the board adjusts the sensitivity of cash compensation to earnings downwards following restatements to constrain earnings management and recover public confidence in the firm.
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