Accounting for the profit sharing bonus is one of the most controversial accounting issue in recent years. Unlike U.S. GAAP and International Accounting Standards, Taiwanese Company Law used to require ‘employee profit sharing bonus’ and ‘profit sharing remuneration to directors ’ be treated as earnings distributions rather than expenses. This practice substantially overstates both reported net income and return on shareholders’ equity, and may cause investors to misprice accounting earnings. From January 1, 2008, Taiwan GAAP requires firms to estimate the profit sharing bonus expense in its financial statement before the actual distribution in the subsequent year. This is to address the accounting discrepancies in the past that firms record the profit sharing scheme at the date when the distribution were made, and bonus and remuneration bypass the Income Statement.
In addition to the accounting discrepancies in the profit sharing scheme, this paper would like to address evidence showing that the current remuneration scheme for directors focusing only on earnings-based pay without balancing the fixed/variable portion and long- and short-term potion of remuneration can deteriorate the efficient role of financial reporting in contracting. It has long been found that accounting conservatism is one of the best controlling mechanisms to constrain managers’ myopic behaviors to decrease shareholders’ value or creditors’ utility; however, the directors’ remuneration scheme in Taiwan might mitigate the efficient role of accounting conservatism. As the directors’ remuneration is linked to net income, this measurement would reduce directors’ and supervisors’ incentives to curb the potential myopic earnings overstatement by management and increase the misalignment of managers and investors (information asymmetry). Our results show that the profit sharing type remuneration diminishes the functioning of directors/supervisors in a good governance structure. It is recommended that the remuneration packages should have a balance between fixed and variable pay and between long and short-term incentives. Firms should also introduce types of performance-based remuneration other than earnings-based remuneration that can help align the long-term interests of management with those of shareholders.