Dodd-Frank Mandated CEO Pay Ratios and Financial Reporting Quality

• In Event: Financial Accounting & Reporting III - Corporate Governance and Corporate Social Responsibility (100 mins)

Abstract

Our research goal is to advance the ongoing debate surrounding the association between a company’s reporting behavior and CEO incentives. The controversial Dodd-Frank CEO pay ratio disclosure requirement provides an opportunity to investigate whether the size of the CEO pay ratio metric supplies useful information to investors about the quality of the company’s financial reporting. Two competing theories of CEO compensation determination predict how a company’s financial reporting quality may be related to the size of the pay ratio. The managerial rent-seeking behavior theory (Bergstresser et al. 2006, Bebchuk and Fried 2004) predicts a negative relationship while the incentive compatible optimal contracting theory (Fama and Jensen 1983, Core, Holthausen and Larker 1999) predicts a positive relationship. Our results indicate a significant and persistent negative association between the size of the pay ratio and accounting quality. Moreover, we find that CEO power and CEO competence affect the relation between CEO pay ratio and managerial reporting behavior. In summary, our results indicate that the pay ratio disclosure may provide useful information to investors that it is consistent with the size of the pay ratio being determined according to the managerial rent-seeking behavior theory.

Authors

• Xiaoyan Cheng, University of Nebraska-Omaha

• David B Smith, University of Nebraska-Lincoln

• Paul N Tanyi, University of Nebraska-Lincoln