Earnings manipulation and the association between CEO bonus and accounting earnings

This study examines whether CEOs of firms that have received an SEC enforcement action for earnings manipulation have a relatively high association between their bonus and accounting earnings. I identify a sample of 61 firms that were issued Accounting and Auditing Enforcement Releases (AAERs) for earnings manipulation between 1996 and 2001 and a control group of firms matched on accounting performance and industry. I investigate whether (i) the association between the CEO bonus and accounting earnings is higher for the AAER firms and (ii) a higher association between the CEO bonus and accounting earnings increases the probability of earnings manipulation. My findings indicate that the association between the CEO bonus and accounting earnings is not significantly higher for firms that manipulate earnings and that the strength of the association does not affect the probability of earnings manipulation. Overall, my results do not support the hypothesis that bonus contracts that place a high weight on accounting earnings provide an incentive for earnings manipulation. Consistent with prior research, I find CEOs who serve as the Chairman of the board, CEOs with short tenure, and the use of a non big-5 audit firm increases the probability of earnings manipulation. This supports the contention that a weak governance structure serves as a catalyst for earnings manipulation.