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An Empirical Investigation of Trends in the Absolute and Relative Use of Earnings in Determining Cash Compensation of CEOs


Robert M. Bushman


University of North Carolina Kenan-Flagler Business School

Ellen Engel


University of Chicago Booth School of Business

Jennifer Milliron


Chicago Partners, LLC

Abbie J. Smith


University of Chicago - Booth School of Business

May 1998


Abstract:     
The purpose of this paper is to provide evidence on whether there have been changes over time in the compensation-earnings relation. We investigate whether there is a trend during the period 1971-95 in the sensitivity of executive pay to reported earnings and in the importance of earnings relative to other information in explaining executive pay. As addressed in Gjesdal [1981] and in the model we develop, the relevance of a performance measure for valuing the firm may not be the same as its relevance for the purpose of inferring managers' contributions to firm value. Whether the decline in the value-relevance of earnings documented in recent research is accompanied by a decline in the stewardship relevance of earnings is an empirical issue that is the focus of this paper.

We estimate pooled regressions of the pay-earnings relation allowing intercepts and slopes to vary by year and industry. While we find significant positive correlation between the sensitivities of firm value and executive pay to earnings, our results fail to detect a general trend in the sensitivity of executive pay to reported earnings. We also conduct similar pooled estimations of the pay-performance relation incorporating non-earnings information reflected in stock prices to assess the importance of earnings relative to other information. Our results suggest that there has been a general decline during the last 25 years in the importance of earnings in explaining cash compensation relative to other information reflected in stock returns.

We further analyze our results indicating a decline in pay-earnings sensitivity relative to information in stock returns in the context of insights gained from existing studies of trends in the value relevance of earnings. We analyze changes in the sensitivity of earnings relative to accounting performance measures that explicitly incorporate balance sheet information. We find that, in contrast to price-earnings studies, the documented decline in relative pay-earnings sensitivity is not attributable to a shift from earnings to balance sheet-based measures. Finally, we examine whether factors capturing aspects of the quality of earnings and firm size that explain the shift in the value relevance from earnings to book values also explain shifts in the relative stewardship relevance of earnings. We find that changes over time in the proportion of intangible-intensive firms, the average magnitude of special items included in earnings and the frequency of negative earnings appear to explain much of the trend in relative pay-earnings sensitivity over the sample period.

Number of Pages in PDF File: 41

JEL Classification: C23, J33, M41

working papers series


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Date posted: October 7, 1998  

Suggested Citation

Bushman, Robert M. and Engel, Ellen and Milliron, Jennifer and Smith, Abbie J., An Empirical Investigation of Trends in the Absolute and Relative Use of Earnings in Determining Cash Compensation of CEOs (May 1998). Available at SSRN: http://ssrn.com/abstract=130910 or http://dx.doi.org/10.2139/ssrn.130910

Contact Information

Robert M. Bushman
University of North Carolina Kenan-Flagler Business School ( email )
McColl Building
Chapel Hill, NC 27599-3490
United States
919-962-9809 (Phone)
HOME PAGE: http://public.kenan-flagler.unc.edu/faculty/bushmanr/

Ellen Engel (Contact Author)
University of Chicago Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-834-0966 (Phone)
866-377-52152 (Fax)
Jennifer C. Milliron
Chicago Partners, LLC
140 S. Dearborn Street
Suite 1500
Chicago, IL 60603
312-251-5908 (Phone)
312-251-5201 (Fax)
Abbie J. Smith
University of Chicago - Booth School of Business ( email )
1101 East 58th Street
Graduate School of Business
Chicago, IL 60637-1561
United States
773-702-7295 (Phone)
773-702-0458 (Fax)
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References:  31
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Footnotes:  28

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