The Impact of Executive Pay and Executive Power on Earnings Management in India

Abstract

Purpose: To examine whether, and the extent to which, executive pay and executive power impact earnings management (EM) behaviour in India. Design/Methodology/Approach: The study applies the modified version of Jones’s (1991, Journal of Accounting Research, 29(2), 193–228) model propounded by Dechow et al. (1995, The Accounting Review, 70(2), 193–225) to measure the proxy for accruals-based EM and the Roychowdhury’s (2006, Journal of Accounting and Economics, 42(3), 335–370) model to measure real EM in 980 listed companies in India during the period 2008–2022. Findings: The study reveals a statistically significant positive relationship between executive pay and EM and between executive power and EM. Further, a statistically significant negative relationship between EM and the interaction effect of executive pay and executive power suggests that well-paid, powerful executives on the board of directors are less likely to pursue EM activity in India. Originality/Value: There are limited studies that utilise a large balanced panel data set of listed companies covering majority of the non-finance industries in the Indian economy over a span of 15 years. The study highlights the significant explanatory power for real EM in comparison to accruals-based EM in India. Implications: The positive link between executive pay and EM suggests that the designing of compensation packages is linked to long-term value creation rather than short-term earnings. The influence of executive power highlights the importance of board independence and balanced CEO power. The negative interaction effect suggests alignment of executive pay and power with long-term company goals to mitigate earnings manipulation.