Compensation Commitment Mechanism,Earnings Management And Their Corporate Governance Effects

Regulators and extensive literature focus on the agency problem in M&A activities in Chinese stock market.For one thing,because of the highly concentration of stocks,the largest shareholders of domestic public listed companies have significant influence on the companies,which enables them to strip the companies by conducting M&A activities.For another,managers of the companies can also conduct value-destroying mergers based on their personal incentives.These factors make the bidding price of the target firms exceed the real economic benefit they can bring to the acquirers and harm the well-beings of the acquirer shareholders in the long run.To deal with this problem,the regulators introduced the compensation commitment mechanism in 2008 to guarantee the profitability of the target asset by using the punishment clauses in the compensation commitment.If the compensation commitment mechanism works,it can help solve the agency problem in the M&A market.However,since the profit of the target can be manipulated,the introduction of the compensation commitment mechanism can also cause earning management activities to help the insiders avoid the potential risk due to the insufficient profit of the target assets.If the later assumption stands,it means that the insiders can avoid the potential risks from their opportunistic activities by conducting new opportunistic activities and thus disables the protection function of related regulations.So it is of vital importance to know if the compensation commitment mechanism really fully functions.Previous research mainly focus on how the opportunistic activities of the managers and the important shareholders affect the M&A decision making and their corresponding economic outcomes.Compared to previous researches,this paper mainly focuses on if the compensation commitment mechanism can cause new opportunistic behaviors based on the assumption of game theory.This paper uses both theoretical analysis and statistic models to investigate if the overall earnings management activities of the companies in the compensation commitment period outperform their counterparts and if the governance mechanism can help mitigate their relationship.The result of this paper finds that during the compensation commitment period,the overall level of earnings management of the commitment companies is significantly higher than other companies.What is more,this paper also finds that the internal and external governance and supervisory mechanisms can not fully mitigate the earnings management during the compensation commitment period due to the unique characteristic of the opportunistic problem during the compensation commitment period and the flexibility for the insiders to choose the most suitable way to manipulate the accounting profit of the target assets.The results still stands after using alternative ways to investigate this problem.This paper also finds that during the compensation commitment period,the likelihood of insiders to reduce their shares is significantly higher and when the compensation commitment period is over,the companies made compensation commitment are more likely to experience a goodwill impairment.Because at this time,the insiders of the M&A activities no longer have the incentives to manipulate the earnings of the target assets and the problems that was covered up by the insiders can be known by the public.The results of this paper show that the insiders of the M&A activities do have incentives to avoid their potential loss in M&A activities and their behaviors have economic outcomes that may harm the companies.This paper shed light on the drawbacks on the existing compensation commitment mechanism.In order to protect the investors more effectively,the regulators need to set up a new standard that covers more factors to evaluate the outcomes of M&A activities to hold the insiders from committing opportunistic behaviors.This paper contributes both to the existing theory and existing practices.Theoretically,this paper enriches both the existing literature on the consequences of compensation commitment mechanism and the literature on the incentives and outcomes of earnings management activities.This paper also provides a guidance for the policy makers to come up with new effective ways to help protect the individual investors in Chinese stock market.The remaining of this paper structures as follows,the first part is the introduction part,the second part is the literature review,the third part is the theoretical analysis and the assumption part,the forth part is the research design part,the fifth part is the empirical result part,the sixth part is the further research part and last part is the conclusion part.