Management ownership, firm size and earnings management

Empirical evidence reveals that managers have incentive to alter reported earnings partly in order to obtain better compensation package. Agency theory suggests that one mechanism to weaken the adverse consequences arising from agency problem is to encourage managerial ownership. This research presents a one-period model that is used in order to predict the association of managerial ownership (n), firm size (s) and the intensity of earnings management (e). In our model, managers select a managed earnings level to optimize their expected earnings. We assume that misreporting is costly for both firms and managers but since managers' compensation is based on their firm's value and firm size optimal behavior induces managers to get involved in earnings management. Our model predicts that firm size is negatively correlated with managed earnings intensity when managers fully control the firm (n ≥ 50%) or when they only own a very small fraction of firm's shares. The effect of substantial managerial ownership on earnings management is more complicated. When the manager owns 50% or more of the firm's shares (i.e., manager completely controls the firm, 0.5 ≤ n < 1), ceteris paribus, the intensity of earnings management and managerial ownership is positively correlated in the area of only minor level of earnings management and negatively correlated in the high level of managed earnings. Managers who own some small fraction of firm shares tend to be less involved in earnings management than managers who own no shares of the firms.;The empirical results in Vietnamese firm data generally support research hypotheses. Additionally, this study investigated earnings management behavior which was reported in prior studies (Burgstahler and Dichev, 1997; Degeorge et al., 1999) and the evidences support the research hypothesis.;Keywords. Earnings management, firm size, managerial ownership.