Say on Pay and Earnings Management

Using a difference-in-differences research design and exploiting the staggered adoption of Sayon-Pay (SoP) laws across the globe, this study examines the effect of SoP on earnings management. An increase in pay-for-performance sensitivity following SoP adoption provides greater incentives for managers to manage earnings to influence their compensation. A concomitant increase in the scrutiny of executive pay and performance measurements, however, may limit earnings management opportunities. We find that SoP adoption does not affect accrual-based earnings management, but increases real earnings management. These results are robust to alternative fixed effects, alternative samples, alternative model specifications, and additional controls for firm-level governance characteristics. The effect of SoP on earnings management is particularly strong in countries with weaker investor protection or those with strong future time reference in languages. Collectively, our results suggest that the adoption of SoP regulations results in an unintended consequence of increasing real earnings management.