The Effect Of Abnormal Pay Dispersion On Earnings Management

Abstract

This study examines the effect of the abnormal pay dispersion on earnings management. Prior studies find that pay dispersion among top executives affect firm performance and executive turnover. We expect that abnormal pay dispersion among top executives affects financial reporting practice as well as firm performance and turnover and provide evidence of positive association between abnormal pay dispersion and earnings management. This result suggests that executives are more likely to be engaged in earnings management to increase their compensation when they feel unfairness from the relative level of compensation. This finding helps financial statement users interpret firm performance and anticipate future outcomes by implying that additional managerial incentives for financial reporting are derived from internal pay dispersion. Our finding that abnormal pay dispersion leads to higher agency costs should also be of interest to shareholders.