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The Impact of Real Earnings Management on Innovation: The Role of Top Executive Compensation

Received: 8 July 2021     Accepted: 19 July 2021     Published: 24 July 2021
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Abstract

Innovation is the key factor to improve the competitiveness of company, with large amount of investment and high risk. Therefore, when facing the pressure of profitability, reducing research and development expenditure is a real earnings management method commonly used by top executives. R&D cuts related to real earnings management belongs to the suboptimal decision-making. Various frictions and high adjustment costs in reduction process may lead to the decline of follow-up innovation. Compensation contract is a governance mechanism for the board of directors to motivate and supervise top executives. Based on the study of the impact of real earnings management on innovation, this paper also analyzes how to design a compensation contract to better mobilize the innovation initiative of executives. This paper chooses the data of Chinese A-share listed companies from 2007 to 2019 to test the economic consequences of real earnings management from innovation perspective by using tobit model. The empirical results show that R&D cuts related to real earnings management can obstruct companies’ innovation, top executive performance pay of non-state-owned enterprises has a negative impact on innovation, and equity incentive can encourage state-owned enterprise executives to improve innovation output. The conclusions highlight the potential costs of managerial manipulation of R&D expenditures to alter reported earnings, and can help to formulate economic policies and top executive compensation contracts to promote innovation.

Published in Journal of Finance and Accounting (Volume 9, Issue 4)
DOI 10.11648/j.jfa.20210904.14
Page(s) 138-144
Creative Commons

This is an Open Access article, distributed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribution and reproduction in any medium or format, provided the original work is properly cited.

Copyright

Copyright © The Author(s), 2021. Published by Science Publishing Group

Keywords

Real Earnings Management, Innovation, Performance Pay, Equity Incentive

References
[1] Roychowdhury S. (2006). Earnings Management through Real Activities Manipulation. Journal of Accounting and Economics, 42 (3): 335-370.
[2] Chan L H, Chen K C W, Chen T Y. (2015). Substitution between Real and Accruals-based Earnings Management after Voluntary Adoption of Compensation Clawback Provisions. The Accounting Review, 90 (1): 147-174.
[3] Dichev I D, Graham J R, Harvey C R. (2013). Earnings Quality: Evidence from the Field. Journal of Accounting and Economics, 56 (2-3): 1-33.
[4] Graham J R, Harvey C R, Rajgopal S. (2005). The Economic Implications of Corporate Financial Reporting. Journal of Accounting and Economics, 40 (1-3): 3-73.
[5] Gunny K A. (2010). The Relation Between Earnings Management Using Real Activities Manipulation and Future Performance: Evidence from Meeting Earnings Benchmarks. Contemporary Accounting Research, 27 (3): 855-888.
[6] Holmstrom B. (1989). Agency Costs and Innovation. Journal of Economic Behavior and Organization, 12 (3): 305-327.
[7] Seru A. (2014). Firm Boundaries Matter: Evidence from Conglomerates and R&D Activity. Journal of Financial Economics, 111 (2): 381-405.
[8] Hall B H. (2002). The Financing of Research and Development. Oxford Review of Economic Policy, 18 (1): 35-51.
[9] Acharya V, Xu Z. (2017). Financial Dependence and Innovation: The case of Public versus Private Firms. Journal of Financial Economics, 124 (2): 223-243.
[10] Jensen M C. (1993). The Modern Industrial Revolution, Exit and the Failure of Internal Control Systems. The Journal of Finance, 48 (3): 831-880.
[11] Firth M, Fung P M Y, Rui O M. (2006). Corporate Performance and CEO Compensation in China. Journal of Corporate Finance, 12 (4): 693-714.
[12] Burgstahler D, Dichev I. (1997). Earnings Management to Avoid Earnings Decreases and Losses. Journal of Accounting and Economics, 24 (1): 99-126.
[13] Jacob J, Jorgensen B N. (2007). Earnings Management and Accounting Income Aggregation. Journal of Accounting and Economics, 43 (2-3): 369-390.
[14] Bereskin F L, Hsu P H, Rotenberg W. (2018). The Real Effects of Real Earnings Management: Evidence from Innovation. Contemporary Accounting Research, 35 (1): 525-557.
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Cite This Article
  • APA Style

    Xiangyi Zhu. (2021). The Impact of Real Earnings Management on Innovation: The Role of Top Executive Compensation. Journal of Finance and Accounting, 9(4), 138-144. https://doi.org/10.11648/j.jfa.20210904.14

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    ACS Style

    Xiangyi Zhu. The Impact of Real Earnings Management on Innovation: The Role of Top Executive Compensation. J. Finance Account. 2021, 9(4), 138-144. doi: 10.11648/j.jfa.20210904.14

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    AMA Style

    Xiangyi Zhu. The Impact of Real Earnings Management on Innovation: The Role of Top Executive Compensation. J Finance Account. 2021;9(4):138-144. doi: 10.11648/j.jfa.20210904.14

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  • @article{10.11648/j.jfa.20210904.14,
      author = {Xiangyi Zhu},
      title = {The Impact of Real Earnings Management on Innovation: The Role of Top Executive Compensation},
      journal = {Journal of Finance and Accounting},
      volume = {9},
      number = {4},
      pages = {138-144},
      doi = {10.11648/j.jfa.20210904.14},
      url = {https://doi.org/10.11648/j.jfa.20210904.14},
      eprint = {https://article.sciencepublishinggroup.com/pdf/10.11648.j.jfa.20210904.14},
      abstract = {Innovation is the key factor to improve the competitiveness of company, with large amount of investment and high risk. Therefore, when facing the pressure of profitability, reducing research and development expenditure is a real earnings management method commonly used by top executives. R&D cuts related to real earnings management belongs to the suboptimal decision-making. Various frictions and high adjustment costs in reduction process may lead to the decline of follow-up innovation. Compensation contract is a governance mechanism for the board of directors to motivate and supervise top executives. Based on the study of the impact of real earnings management on innovation, this paper also analyzes how to design a compensation contract to better mobilize the innovation initiative of executives. This paper chooses the data of Chinese A-share listed companies from 2007 to 2019 to test the economic consequences of real earnings management from innovation perspective by using tobit model. The empirical results show that R&D cuts related to real earnings management can obstruct companies’ innovation, top executive performance pay of non-state-owned enterprises has a negative impact on innovation, and equity incentive can encourage state-owned enterprise executives to improve innovation output. The conclusions highlight the potential costs of managerial manipulation of R&D expenditures to alter reported earnings, and can help to formulate economic policies and top executive compensation contracts to promote innovation.},
     year = {2021}
    }
    

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  • TY  - JOUR
    T1  - The Impact of Real Earnings Management on Innovation: The Role of Top Executive Compensation
    AU  - Xiangyi Zhu
    Y1  - 2021/07/24
    PY  - 2021
    N1  - https://doi.org/10.11648/j.jfa.20210904.14
    DO  - 10.11648/j.jfa.20210904.14
    T2  - Journal of Finance and Accounting
    JF  - Journal of Finance and Accounting
    JO  - Journal of Finance and Accounting
    SP  - 138
    EP  - 144
    PB  - Science Publishing Group
    SN  - 2330-7323
    UR  - https://doi.org/10.11648/j.jfa.20210904.14
    AB  - Innovation is the key factor to improve the competitiveness of company, with large amount of investment and high risk. Therefore, when facing the pressure of profitability, reducing research and development expenditure is a real earnings management method commonly used by top executives. R&D cuts related to real earnings management belongs to the suboptimal decision-making. Various frictions and high adjustment costs in reduction process may lead to the decline of follow-up innovation. Compensation contract is a governance mechanism for the board of directors to motivate and supervise top executives. Based on the study of the impact of real earnings management on innovation, this paper also analyzes how to design a compensation contract to better mobilize the innovation initiative of executives. This paper chooses the data of Chinese A-share listed companies from 2007 to 2019 to test the economic consequences of real earnings management from innovation perspective by using tobit model. The empirical results show that R&D cuts related to real earnings management can obstruct companies’ innovation, top executive performance pay of non-state-owned enterprises has a negative impact on innovation, and equity incentive can encourage state-owned enterprise executives to improve innovation output. The conclusions highlight the potential costs of managerial manipulation of R&D expenditures to alter reported earnings, and can help to formulate economic policies and top executive compensation contracts to promote innovation.
    VL  - 9
    IS  - 4
    ER  - 

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Author Information
  • Business School, Shandong University of Technology, Zibo, China

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