Impact of Financial Crises on CEO Compensation and Earnings Management

This article examines the effects of global financial crises on CEO compensations and their earning management relationship. It analyzes the impact of economic fluctuations on earning management decisions and the inconsistencies in accounting standards and policies caused by financial crises. The research focuses on the relationship between CEO bonus and discretionary accruals during financial crises and suggests improvements in accounting standards.

Contemporary issues in accounting
theory

Article: Assenso-Okofo, O., Ali, J. and Ahmed, K., 2020. The effects of global
financial crisis on the relationship between CEO compensation and
earnings management. International Journal of Accounting & Information
Management.
Chapter 1 – topic 1.10
This research is mainly done with purpose to examine the effects of global financial crises
on CEO (chief executive officers) compensations and their earning management relationship that
varies with economic cycle especially the Global Financial Crises(GFC), the present article is
chosen, where authors have taken observations over a period of six years from 2005 to 2010, first
time in the history. Specifically, the authors hereby, focuses mainly on financial crisis to analyse
whether it influences the relationship between CEO bonus and discretionary accruals. A number
of nations enacted legislations regarding with excessive payment to chief executive officers, for
raising voice of shareholders with disagreement on their remuneration plans. For this purpose, a
deep analysis is made under this research, over various firms of different countries like Malaysia,
Australia and Asian ones, to analyse the factors that impact on earning management and arise
inconsistencies in accounting standards and policies. During GFC, companies are unable for
achieving their targets therefore, to meet any predetermined target, they used to manipulate
earnings, which might have a potential effect on earnings management on compensation of CEO.
Therefore, taking this article help in exploring the facts how financial crises effect CEO
compensations and earning management, so that improvement could be made in accounting
standards to overcome from the same. The practical implications which includes findings, justify
more monitoring as well as scrutiny, for limiting existence of the opportunistic managerial
behaviour. It also further aid in appropriate designing the CEO compensation packages,
especially during GFC or abnormal economic situations.
Chapter 2 – topic: 2.20
As per this article, it has been analysed that accounting standards consist flexibilities,
therefore, can be used for managing the reported earnings within varied earnings. Evidence that
shown application of accounting standards in the same includes case study of distressed firms in
Malaysia, where in financial crisis period, they have been made negotiation with banks by
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manipulating increasing or decreasing DACC i.e. discretionary accruals for extracting more
benefits. It illustrates the significant influence of economic fluctuations on earning management
decisions of firms, during GFC period. This may also tend to alter relationship between CEO
compensation as well as in earnings management, as per depending on nature and various form
of factors. Through prior research in this article, it has been identified that CEO compensation
policies are mostly tied with an upfront earning target instead of actual performance. So, this
factor increase inconsistency in accounting standards, because of the compensation-maximising
considerations, where executives might have various choices to boost and shift current earnings
of them. Furthermore, as BCOM i.e. bonus compensation that can manipulate the earning
management, is highly linked with accounting standards. Therefore, both cash bonus component
as per basis on performance, motivate CEOs for manipulating the earnings.
Moreover, CEO are considered as main strategic decision maker in a firm, so, their
compensation seems to have major impact on corporate strategic decisions. In this regard,
conducting a study over CEOs of Australia in this article, it has been evaluated that there is a
strong link between stock options in a firm and adoption of aggressive accounting practices. In
other words, it has been identified that desire to achieve personal goals, availability of stock
options and contractual reasons are being motivating reasons for managers, to be involved within
aggressive accounting practices. So, this would further lead to restatement as well. Therefore, all
these evidences reflect that due to keen interest of CEOs for achievement of personal goals
instead of company’s objectives, inconsistency always occur within accounting standards and
conceptual frameworks.
However, through this article, it has also been identified that there is a positive
relationship form between cash bonus and economic growth in Australia, where being engaged
in manage earnings, large firms get benefits to sustain their good performance at market. But
depending on the nature of factors like extreme conditions of macroeconomic environment, both
earning management and CEO compensation are highly influenced. When firms experience huge
financial problems then they manipulate earning that goes beyond accounting standards. One of
such example that illustrate this fact is emerged from 1997 Asian financial crisis, which has
suggested the existence of earnings management via DACC choices.
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Personal reflection:
After reading this article where, authors mainly reflect the impact of financial crises on
relationship between CEO’s compensation and management earnings, it has been evaluated that
during these periods, accounting standards and norms are highly fluctuated. I have been
acknowledged clear and in precise manner, about how personal beliefs influences the bonus and
other compensation of CEO which arises inconsistencies in accounting. Therefore, it is essential
for every firm to make proper payment and other packages for their CEOs, so that positive
contribution of them could be gained for meeting the criteria or corporate objectives of business,
rather than their personal goals. Reading this research paper, also aid me to analyse relationship
between CEO compensation that varies with economic situation, which is more weaker on post-
GFC instead of prior GFC. The results obtained through various practical implications in this
research paper, illustrates the rationale behind regulatory bodies scrutinising, which is more
closely to demand disclosure and requirements for reducing the managers’ opportunistic
behaviour. Furthermore, outcomes of this paper also aid law-makers, shareholders, investors and
board of directors of companies for understanding the managerial opportunistic incentives. It
also contributes to update existing knowledge as well as extends the literature regarding with
relationship between CEO compensation and earnings management, for analysing the role of
economic environment in the same.
Key Explanation –
As main topic of this assessment is “Contemporary issues in accounting theory”, therefore,
Chapter 1 (1.10) and Chapter 2 (2.20) attempt in this report are both demonstrates the key effects
of global financial crisis on the relationship between CEO compensation and earnings
management. A brief explanation was made on critically reviewing the chosen article about how
economical fluctuations influences a company’s financial accounting standards, where to meet
business needs in terms of CEO compensations, employers or managers manipulate the earnings.
Similarly, another topic i.e. The conceptual framework for financial reporting and standard
setting, also somehow relates with content with key explanation of accounting standards. To
attempt and meet given criteria of both topics, I have reviewed chosen article critically, so that
effectiveness of report can be maintained.
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