Pay Disparity and Financial Reporting Behavior

Abstract

Our study examines the relationship between executive pay disparity and firms’ financial reporting behavior. Tournament theory suggests that compensation differences between the CEO and other top management team executives can promote greater performance and reduce CEO entrenchment. We posit that pay disparity can also result in financial reporting behaviors that lower stakeholders’ disclosure integration costs. We analyze two dimensions of financial reporting, financial reporting similarity and timeliness. We find that a larger pay disparity between the CEO and other top executives is associated with greater financial reporting similarity and timelier financial reporting. Further, we note that equity-based compensation, as opposed to salary compensation, appears to be driving these relationships, consistent with tournament theory. We provide evidence that tournament incentives can result in firms providing external stakeholders with timely and usable financial information, particularly if such incentives are prompted by equity compensation differences.

Keywords: Financial Reporting Similarity, Timeliness, Pay Disparity, Tournament Theory, Information Processing Costs