Supervisory Board Compensation Structure, Employee Representation, and Earnings Management: Evidence from German Boards
41 Pages Posted: 19 Aug 2014 Last revised: 29 Jun 2016
Date Written: June 29, 2016
Abstract
In this paper, I examine the compensation contracts of German shareholder and employee representatives as well as the role of co-determined supervisory boards and the impact on earnings management. The supervisory board participates in the firm’s decision-making, but also has the key fiduciary responsibility to audit and approve the annual financial statements. In numerous cases shareholder representatives’ bonus plans are tied to financial performance, raising concerns about the integrity of financial reporting. In contrast, employee representatives are required to forward their remuneration to the Hans Böckler Foundation and can only keep a small fixed amount. In my sample of 357 firm-year observations, the results indicate that supervisory boards that receive a larger proportion of their compensation as long-term cash incentives are more likely to have higher levels of absolute discretionary accruals. However, I find that employee representation can mitigate the positive effect of a higher proportion of long-term bonus payments on the magnitude of discretionary accruals. Finally, I also find a direct negative relation between co-determined supervisory boards and earnings management, indicating that co-determined supervisory boards are more likely to monitor the financial reporting process.
Keywords: corporate governance, supervisory board, two-tier system, performance-based compensation, employee representation, earnings management, discretionary accruals
JEL Classification: M52
Suggested Citation: Suggested Citation