Executive heterogeneity, pay bandwagon, and earnings management

Abstract

Purpose From the perspective of top management heterogeneity, this paper aims to study the impact of the psychological traits of executive pay bandwagon on earnings management in the listed companies of China. Design/methodology/approach This paper applies the ratio of executive pay to the median pay level of executives in firms of similar size and industry, namely, the comparing coefficient, as an alternative variable of executive pay bandwagon, and earnings management as the behavior choice of executive pay bandwagon, to examine whether executives in the listed companies of China have comparing mentality, and whether the result is influenced by executive heterogeneity by using the multiple linear regression models. Findings The lower the executives’ compensation is than the median pay level of executives in firms of similar size and industry, the stronger the incentive the executives have to compare with others whose pay is higher, increasing the extent of earnings management in the future, and executives tend to use real activities manipulation rather than accrual-based earnings management to increase their performance-based compensation. As pay bandwagon is a kind of executives’ individual psychological reaction, in a large extent, its behavioral performance is likely to be affected by executive heterogeneity. Specifically, when the proportion of male executives, young executives or low educated executives is relatively high, or executives are located in remote cities, there will breed more earnings management behaviors induced by pay bandwagon. Further study shows that pay bandwagon is positively correlated with rigging compensation based on real earnings management and pay bandwagon also has significantly negative effects on the firms’ future value creation. Research limitations/implications Pay bandwagon is an important inducement of executives’ earnings management, with implication that for executives with different characteristics, one should pay attention to the subjective psychological perception and expectation of their pay in the future studies related to executives’ compensation incentives. Originality/value This study introduces the research within sociology, psychology and experimental economics, and considers the executives’ subjective perception of their pay, to explore the internal mechanism that executives affect firm performance via a specific earnings management method and to implement self-interested behavior due to pay bandwagon. And this is the first study to select several typical executive individual characteristics to investigate the influence of executive heterogeneity on pay bandwagon and its economic consequences.

Executive pay bandwagon and stock price crash risk

“…Once acquired an unfair cognition after comparing with others, executives would take measures to eliminate the negative emotions of fair tension. Luo et al (2016) provide empirical evidence that the executives of listed companies in China do have the psychology of compensation comparison and note that executives are more likely to manipulate compensation through real earnings management. Quan et al (2010) conclude that performance-based pay contracts increase the incentive for management to manipulate performance compensation through earnings management.…”

“…Following Luo et al (2016), we apply the ratio of executive pay to the median pay level of executives in firms of similar size and industry, namely the comparison coefficient, as an alternate variable of executive pay bandwagon.…”

“…Motivated by agency theory and bad news concealment theory, we investigate the relation between executive pay bandwagon and crash risk. From the perspective of agency theory, once executives find themselves paid less than other executives in the same industry, they will experience a sense of tension or anxiety due to comparing mentality (Luo et al, 2016). Out of self-interested motivation, they will take action Stock price crash risk to alleviate the negative emotions driven by the unfair perception.…”

“…When the accumulated negative information reaches a tipping point, it will be suddenly released to the stock market, all at once, resulting in the bubble bursting and a stock price crash (Jin and Myers, 2006;Hutton et al, 2009;Kim et al, 2011a). Given that the pay bandwagon mentality may prompt executives to manipulate compensation through earnings management and search for invisible benefits using tax avoidance or firm expansion (Luo et al, 2015;Luo et al, 2016;Luo and Zeng, 2018). Thus, it is important to understand whether and how executives' behavior choices based on the pay bandwagon exacerbate the company's future stock price crash risk.…”

Does corporate social responsibility mediate the influence of national culture on investment inefficiency? Firm‐level evidence from Asia Pacific

“…1 The theoretical premises of the former perspective lean on the self‐interest of firm managers and/or the controlling shareholders that reroute firm resources in a way that matches with their interest only, which, in turn, significantly hampers the optimal level of investment. Thus, this perspective generally leads to over‐investment problem (Luo, Zeng, Wan, & Shen, 2016; Jiang, Kim, & Pang, 2011). The latter perspective draws inferences from the unavailability of the same level of information to all stakeholders in capital markets, commonly known as information asymmetry.…”