Pay Gap and Accounting Conservatism

. This paper investigates the impact of the pay gap on accounting conservatism based on the basic data of A-share listed companies in Shang-hai and Shenzhen from 2008 to 2020 by using multivariate linear regression model and OLS regression method, ﬁnding that the two are signiﬁcantly negatively correlated. By introducing Confucian culture, this paper further explores the moderating role of Confucianism and ﬁnds that enterprises inﬂuenced by Confucian culture emphasize collectivism, which also increases the accounting conservatism. This paper expands the research of accounting conservatism and explains the relationship between the pay gap and accounting conservatism from the perspective of corporate governance and Confucian culture, encouraging companies to strengthen cultural construction and absorb the essence of Chinese


Introduction
In 2021, China has achieved a comprehensive victory in the fight against poverty. From "poverty alleviation" to "common prosperity", it is a natural connection and the ultimate goal of the strategy. On August 17, 2021, at the tenth meeting of the Central Finance and Economic Commission, the regulation of excessive income and common prosperity was emphasized again. China has made many institutional arrangements to narrow the gap between the rich and the poor and ultimately achieve common prosperity. This also illustrates the significance of the academic research on the issue of corporate pay gap. Existing studies have focused on the relationship between the pay gap and corporate performance and innovation level [1][2][3], and there are currently fewer studies linking pay gap with accounting conservatism.
Accounting conservatism is an important principle for the confirmation and measurement of accounting information. It requires companies to carefully confirm "good news" and timely reflect "bad news", which is of great significance to the long-term development of enterprises and the stable operation of the capital market: In China's special institutional environment, accounting conservatism can help increase the opportunities for companies to obtain external financing, reduce financing costs and improve investment efficiency [4]. It also helps companies to send signals to stakeholders in a timely manner, alleviate information asymmetry, and reduce agency costs [5,6].
Watts believes that the distribution of interests among shareholders, management and creditors is the main contractual reason for accounting conservatism [7]. But what's the connection between the company's pay gap and accounting conservatism?
This study intends to answer the question. The main contributions are: 1) Comprehensively measure the company's pay gap from multiple perspectives; 2) Provide ideas for companies to design more effective compensation contracts to meet higher accounting conservatism needs; 3) In addition to explain the relationship between pay gap and accounting conservatism from the governance perspective, and also from the perspective of Confucianism, inspiring enterprises to fully absorb the nutrients of Chinese excellent traditional culture when constructing organizational culture. This paper is divided into seven chapters. The main content is the influence of pay gap on accounting conservatism. And the specific structure is as follows: Section 1 introduces the research background and significance; Section 2 combs the relevant literature at home and abroad; Section 3 puts forward the hypothesis on the theoretical basis; In Section 4 to Section 5, the regression test is completed after designing the model, and the two-stage least square method is used for the endogenous test; Next, this paper further analyzes the impact of Confucian culture and directors' overseas background on the pay gap and accounting conservatism; The last part is the conclusion and references.

Literature Review
Many studies have focused on the incentive effect of the pay gap. In this regard, there are two main theories in the academic circle: tournament theory and behavioral theory. Tournament proposed by Lazear and Rosen believes that the pay gap is positively correlated with company performance [8]. However, behavioral theory believes that salary gap will induce employees' unfair psychology and have a negative effect on performance. This has been confirmed by scholars at home and abroad [9,10].
Basu interpreted the principle of conservatism as gains that reflect "bad news" available to the public more timely or more sensitively than "good news" [11]. For example, unrealized losses are usually recognized earlier than unrealized gains because the recognition of "good news" requires a higher degree of verification. Watts put forward the accounting conservatism contract, and believed that debt contracts, management compensation contracts and employment contracts are important reasons for accounting conservatism [7]. Subsequent studies have basically revolved around the influencing factors of accounting conservatism.
Reference [12] believes that the purpose of accounting information conservatism is to reduce financial risks, and because the payment of employee compensation will increase the risk of corporate bankruptcy, employee compensation and accounting conservatism are positively correlated. The greater salary gap between executives and employees, the more they can incentivize executives to manipulate company performance, and in companies with concentrated equity, this reverse incentive effect is stronger [13]. Johnathon [14] innovatively studied government unconditional accounting conservatism. There are also scholars from the environment [15,16], the background characteristics of the executive team [17,18], corporate strategy types [19], regulation [16,20] and other perspectives to study the impact on accounting conservatism.

Theoretical Analysis and Research Hypothesis
Tournament theory illustrates the incentive effect of compensation, but the large compensation gap also provides incentives for executives to manipulate earnings. Under short-term compensation contracts, in order to achieve a larger pay gap, executives are more motivated to manipulate earnings to modify accounting indicators for performance evaluation [21]. Accounting conservatism can alleviate the governance problems, and effectively reduce agency costs. A large pay gap may reduce the need for the accounting conservatism of executives, because in the performance-based compensation mechanism, they need more radical accounting policies to obtain more income.
In addition, China's restrictive measures on the pay gap are consistent with Confucian traditional ideas. The formation of organizational culture is highly path-dependent and is the result of long-term institutional arrangements. And the design of the compensation system will shape the corporate culture and directly express the core values. Compensation designed with a large gap can reflect the free and active corporate culture, and the "equal" salary system can reflect the Confucian collectivism in corporate culture which restrain corporate executives to take into account the interests of all parties [22] and must go through the consensus of the team, adopt consistent policies, make decisions cautiously when choosing company strategies and accounting policies, therefore, increase accounting robustness of information.
Furthermore, employees will fully consider the growth and stability of wages. When wages are high, they will be more motivated to require enterprises to be stable and reduce the risk of not being able to pay wages, because paying wages will cause a large outflow of corporate cash flow [12]. In the case of a small salary gap with executives, employees may think that there is not much room for increase in wages, and they are more satisfied with the stable payment of wages, thus increasing the demand for stable accounting treatment of enterprises. Based on the above analysis: Hypothesis 1. A larger pay gap of an enterprise leads to less accounting conservatism.

Research Design
Since China began to implement new accounting standards in 2007, this paper selects the data of listed companies in Shanghai and Shenzhen from 2008 to 2020 as the research sample, which mainly comes from the CSMAR database. By data processing, the financial industry, ST and *ST listed companies are excluded, and samples with missing and abnormal data are excluded. Through effective screening, the final sample size is 17,412. After winsorize (1%) processing of continuous variables with extreme values, this paper uses STATA software to test and analyze.

Variables Definition
(1) Explained variable There are generally three measurement models for the accounting conservatism: One is the Basu model, which is the reverse regression method of earnings compensation proposed by Basu [11]. The second is the Cscore model, that is, Khan and Watts [6] based on the Basu model, use company size (SIZE), market value to book ratio (MB) and asset-liability ratio (LEV) to build the regression model. The third is the Accrual model, which is the accrual cash flow model of Ball and Shivakumar [23].
Since the Cscore model is easier to add control variables to control other factors that may affect accounting conservatism, based on the reference [12], this paper chooses the Cscore model to measure the firm's accounting conservatism.
(2) Explanatory variables This paper defines the pay gap of an enterprise from the perspective of management, emphasizing the management team with decision-making power. Therefore, the executives, managers, and management defined in the paper refer to the overall team including directors, supervisors, and senior managers. In order to fully reflect the monetary pay gap of the management, this paper uses the following variables to express the pay gap (Gap): Year Year fixed effect Gap1 is defined as the natural logarithm of the difference between the top three average annual salary of management salary and the average annual salary of the management. Gap2 is the relative index based on it [24]. Gap3 is the natural logarithm of the difference between the average annual salary of management and the average annual salary of ordinary employees, and Gap4 is the ratio of the two [25]. (

3) Control variables
In order to more accurately reflect the relationship between the explained variables and the explanatory variables, this study introduces control variables on the basis of reviewing the literature: the nature of equity (En), the concurrent appointment of chairman and general manager (Dual), the largest shareholder holding ratio (First), independent director ratio (Indirector), corporate performance (Roa), agency cost (Cost), cash holdings (Cash), corporate age (Age), management holding level (Mh), industry (Ind) and year (Year). The following table 1 describes all variables.

Descriptive Analysis
As can be seen from table 2, the average value of accounting conservatism is -0.022, which is less than 0, indicating that the accounting information conservatism of listed companies is on average low. In addition, table 2 shows that the salary in the average relative difference between the senior management team is 1.677, which is reasonable, while the average relative difference between the senior management and employees is 5.359, which illustrates a big difference in income distribution.

Regression Analysis
The regression results from column (1) to column (4) in table 3 all reach a significant level of 1%, and the regression coefficients are all negative numbers. It fully verifies Hypothesis 1, indicating that the enterprise' pay gap will significantly reduce accounting conservatism. On the one hand, in a performance-oriented salary system, executives may choose radical  accounting policies to confirm accounting earnings in order to obtain higher levels of salary. This is also consistent with the negative regression coefficient of the control variable company performance (Roa) in table 3. It also shows that employees prefer the stability of wages when there is a small salary difference with management, and require more sound accounting treatment. On the other hand, the Confucian "equalization" thought and collectivist orientation contained in the corporate culture make the greater salary heterogeneity weaken accounting conservatism.

Robustness Test
In this paper, the following robustness tests are used:1) One-period lagging continuous variable; 2) Adding control variables such as operating cash flow, innovation input intensity, institutional investor shareholding ratio, and separation rate of two rights. The results are robust. Further, to solve endogenous problem, drawing on the reference [26], the average number of executives and the average pay gap of other companies in the same industry in the sample are selected as instrumental variables for the pay gap between the executive team and the pay gap between executives and employees. Then the two-stage least squares method is used for testing. The results in table 4 show that the predicted value of the pay gap is still significantly negatively correlated with accounting conservatism. The tables of robustness tests are not reported in this paper due to the length limit.

Further Research
(1) The moderating effect of Confucian culture The distribution of wealth will be affected by the idea of "equalization" of Confucian [22]. Generally speaking, companies affected by Confucian culture will design smaller salary differences, and will be more able to restrict managers to consider collective opinions to make decisions cautiously, choose conservative policies, and increase the robustness of accounting information. Therefore, this study further adds Confucian culture variables to test the moderating effect of Confucianism on the relationship between corporate pay gap and accounting conservatism. Refer to the "social-oriented collectivism" (Cul) [27] to measure Confucian culture.
Hypothesis 2. In a company deeply influenced by Confucian culture, a smaller pay gap leads to higher accounting conservatism.
The model 1 was regressed by adding the variables of Confucian culture (Cul) and the interaction terms of Gap with Confucian culture (Gap*Cul). The results in table 5 show that the regression coefficients of Gap are still significantly negative, and the interaction terms of Gap1, Gap2, and Gap4 with Confucian culture variables are also significantly negative, which validates Hypothesis 2. It shows that Confucian collectivism can influence managers to prefer a more even compensation system design, which results higher accounting conservatism.  (2) The influence of directors' overseas background Eastern culture has integral characteristics, while the core problem of western culture is to emphasize the exertion of individual freedom, which is the essence of individual culture. Obviously, there is a big difference between western individual culture and Chinese collective culture. The decision-making behavior of managers with overseas background may be influenced by western culture. Therefore, this paper further investigates the impact of pay gap on accounting conservatism from the perspective of directors' background.
Divide the full sample into two sub-samples of directors with overseas background and directors without overseas background, and then regress model 1 in the two groups. The results are shown in table 6. It can be found that in the sample of directors with overseas background, the impact of salary gap (Gap1-Gap4) on accounting conservatism is still negatively significant, and the absolute value of the regression coefficient is larger, which means that the board of directors with overseas background is influenced by overseas culture and makes more open and radical decision-making. This is consistent with the research conclusions of Liu and Kong that the returnee executives who are deeply influenced by western culture have a greater impact on the corporate compensation system and can significantly improve the level of internal compensation gaps [28]. Robust t-statistics in parentheses, *** p<0.01, ** p<0.05, * p<0.1

Conclusion
This paper studies the relationship between corporate's pay gap and accounting conservatism from multiple perspectives such as senior management team and employees. For companies with smaller pay gap, the demands of executives and employees for accounting conservatism will increase, which is also consistent with the Confucian culture's "equalization" thinking and collectivist idea. Furthermore, this paper verifies that companies influenced by Confucian culture will strengthen the role of pay fairness in accounting conservatism. These conclusions provide ideas for China to enhance the accounting conservatism of capital market from the perspective of pay, and provide suggestions for enterprises to strengthen cultural construction by absorbing the essence of Chinese excellent traditional culture.