The relationship between executive remuneration and earnings management: incorporating the disclosure quality of financial reporting judgements

Abstract According to managerial power theory, executives may be biased in their financial reporting judgements (FRJs), which can lead to accounting choices that increase earnings and potentially result in abnormal (excessive) executive remuneration. Global empirical studies suggest that the pursuit of higher executive remuneration can incentivise earnings management (EM) engagement. However, previous research on the relationship between EM and executive remuneration has mainly focused on developed countries, used accrual-based EM proxies, and often included only chief executive officer remuneration. The main objective of the study was to investigate the relationship between EM and executive remuneration in South Africa, a developing country, using the disclosure quality of FRJs as a measure of EM. Another unique contribution entails a more comprehensive measure of executive remuneration, covering all executive directors, and an indicator of whether the remuneration was deemed abnormal. Understanding this relationship in South Africa is vital, given the existing high levels of income inequality, particularly from a social justice perspective. Using a quantitative approach, the research examined 101 Johannesburg Stock Exchange-listed companies from 2020 to 2023. Applying regression analysis, the study found that executives may indeed be biased in their FRJs, leading to abnormal executive remuneration. The findings highlight the need for ongoing monitoring of remuneration and the quality of FRJ disclosures to mitigate the risk of rent extraction and to curb executives’ opportunistic behaviour. Without such oversight, using EM strategies to secure abnormal remuneration will erode public trust.