Do Chinese Listed Firms Actively Alter the Design of Pay-Performance Sensitivity Following Financial Restatements?

The high sensitivity of management compensation to accounting performance could be an important driver of financial restatement, due to strong management incentives to manipulate earnings. This paper examines whether restating firms rearrange management's annual compensation following restatement announcements to decrease management's incentives to misreport. Based on observations between 2003 and 2011 in the Chinese capital market, this paper finds that accounting-based pay-performance sensitivity decreases and market-based pay-performance sensitivity increases in restating firms following restatement announcements. These findings indicate that active corporate governance in Chinese listed firms can redesign compensation packages to constrain management incentives to misreport. Furthermore, we find that the effect of financial restatement on pay-performance sensitivity is weaker in state-owned enterprises than in non-state-owned enterprises, indicating that compensation design as a tool to alleviate agency costs could, to some extent, lose its effectiveness in reducing management's opportunistic behavior in state-owned enterprises