Directors' Incentives and Earnings Management: An Empirical Study Based on Chinese Listed Firms

This paper empirically investigates the relationship between directors' incentives and earnings management based on a sample of Chinese listed firms during the period 2003-2005. Earnings management is measured by income-increasing extraordinary items. The empirical result of this study indicates that directors' cash compensation is negatively associated with income-increasing extraordinary items. However, we find no evidence of an association between directors' equity incentives and income-increasing extraordinary items. The result may imply that directors' equity incentives are not effective in Chinese firms, and that it is necessary for Chinese listed firms to design an efficient incentive contract for directors to strengthen the effectiveness of board as an internal control mechanism.