Discretionary Accounting Choices and CEO Compensation

This paper make four important contributions to the accounting literature. First, it shows that discretionary accruals are associated with CEO cash compensation, but that the coefficient is significantly less than that on nondiscretionary accruals. Second, a differential reaction is found to positive and negative discretionary accruals, i.e., only positive discretionary accruals are significantly associated with CEO cash compensation. Third, the association between discretionary accruals and CEO cash compensation varies depending upon the circumstances of the firm, i.e., the association of CEO cash compensation with positive discretionary accruals is stronger when the firm uses those discretionary accruals to achieve its earnings goal. Finally, the association of CEO cash compensation with reported net income generally increases with the level of discretionary accruals, consistent with management responding to the incentives provided. However when the level of discretionary accruals becomes extremely high (top 1%) the association between CEO cash compensation and positive discretionary accruals becomes insignificant, consistent with there being a limit on the ability of management to increase its compensation through discretionary accruals