CEO pay-performance and board independence: the impact of earnings management in China

This paper examines the impact of board characteristics and CEO compensation on firm performance when firm performance is adjusted for the effect of earnings management. Results from regression analysis indicates that the CEO pay-performance relation is substantially lower when firm performance is adjusted for the effect of earnings management than when firm performance is measured as reported performance. That is, the positive effect of executive compensation on firm performance disappears when firm performance is measured as adjusted firm performance excluding earnings management in Chinese listed firms, and as a result, we can identify that the evident executive pay-performance relation is largely cosmetic. We also find that the proportion of independent directors on board is significantly positively associated with firm performance only when the firm performance is adjusted for the effect of earnings management. These results suggest that independent directors are shown as more effective governance mechanism in Chinese listed firms when true firm performance is considered while the positive effect of CEO compensation disappears concerning true firm performance