Does Pay for Performance Reduce Earnings Management in France ?

Abstract

The purpose of this paper is to examine the relationship between performance-based CEO compensation and earnings management by French managers. The French context is worthy to study given that firms are mostly held by families. CEO compensation in such firms is used as a tunneling mechanism to expropriate minority shareholders. Using a sample of French listed firms, we study how bonuses and CEO stock-option compensation affect earnings management practices. The findings show that managers are inclined to increase the variable part of their compensation by engaging in earnings management practices. Furthermore, we find that the amount of stock-options granted and exercised is positively associated to upward earnings management. These findings highlight manager’s opportunistic behaviour upon performance-based compensation which rather acts as a tunnelling mechanism than a corporate governance device.

Keywords: Stock-option, Bonus, Earnings management