The Nexus Between CEO Incentives and Earnings Management

This study investigates the relationship between Chief Executive Officer (CEO) incentives and earnings management in publicly traded firms, a subject that remains contentious in accounting and corporate governance literature. The central problem addressed is the potential misalignment between CEO compensation structures, especially those heavily tied to firm performance, and the integrity of reported financial results. Earnings management, whether through accrual-based or real activities manipulation, can distort financial transparency, mislead stakeholders, and undermine market efficiency. The purpose of this study is to examine whether performance-based CEO incentives (e.g., stock options, bonuses, and equity holdings) are associated with increased tendencies to manipulate earnings. By focusing on the incentive structures, the study aims to assess how reward mechanisms may inadvertently encourage short-termism and financial misreporting. Using a quantitative research design, panel data from 147 publicly listed companies over ten years (2014–2023) were analyzed. Earnings management was proxied through discretionary accruals measured using the Modified Jones Model, while CEO incentives were captured through a composite index of equity-based and non-equity-based compensation. A random effects panel regression model was employed to test the relationship, controlling for firm-specific variables. The findings reveal a significant positive relationship between equity-based CEO incentives and the extent of earnings management, suggesting that the structure of CEO compensation plays a critical role in shaping financial reporting behavior. Non-equity incentives, however, showed no significant association. These results highlight the risk that equity-linked compensation may motivate executives to engage in earnings manipulation to meet performance targets and boost personal wealth. This study is limited by its reliance on secondary data, which may not fully capture all dimensions of CEO incentives or earnings manipulation strategies. Moreover, the focus on publicly listed firms limits the generalizability to private or state-owned enterprises. The practical implications underscore the need for boards and compensation committees to design CEO incentive schemes that align long-term shareholder interests with ethical reporting practices. Socially, the study emphasizes the importance of transparent financial reporting in fostering investor trust and protecting market integrity. The originality of this research lies in its comprehensive treatment of both accrual and real earnings management techniques regarding disaggregated CEO compensation components, thereby contributing fresh insights to the executive incentives literature in the context of corporate governance reforms.