The Treatment of Special Items in Determining CEO Cash Compensation

Abstract

Existing literature shows CEOs are rewarded for any positive component of income and are partially shielded from negative special items. However, the incidence of and rules pertaining to nonrecurring items significantly changed over the last two decades. I uncover that executives benefit less from positive nonrecurring items and are penalized more for negative special items compared to earlier periods. The predictive ability of the components of income helps explain this shift. Detailed, hand-collected data indicates that compensation committees are more likely to include a component of income capable of predicting future earnings in their CEO bonus performance measure. Changes in the predictive ability of the nonrecurring components of income over time contribute to shifts in their treatment in calculating CEO pay.

Keywords: executive compensation, executive bonuses, income-decreasing special items, income-increasing special items, extraordinary items, discontinued operations