Game analysis on the motivation of equity incentive contracts in the presence of earnings management

This paper develops a game analysis model of choosing incentive contract in the presence of earnings management. The model shows that, lower efficiency of the capital market would lead weaker motivation for companies implementing equity incentive. In China, the primary motivation of equity incentive is to pursue Pareto Efficiency by inspiring managers to increase the long-term value of their company. In addition, Pareto improvement each player can share depends on the level of incentive. Given that the managers will use their power to increase the incentive level, a simple and feasible way for companies to implement equity incentive is to keep the same equivalent utility of incentive level with their original bonus scheme.