Measuring Delivered Performance
Working Paper FR 96-07
Posted: 8 Sep 1997
Date Written: Undated
We show that compensation contracts based on measures of Delivered performance are less costly to shareholders. We compare stock-price changes, earnings, and cash flows as performance measures, and predict that each measure's use in contracts will increase in its contemporaneous correlation with delivered performance. We discuss settings in which each measure has higher contemporaneous correlation with delivered performance than the others. Earnings-based compensation plans are sometimes superior to price-based plans because prices confound delivered performance with expected future performance, and they are sometimes inferior to price-based plans because earnings can lag delivered performance. If mark-to-market accounting causes these expectations to be incorporated in book values, then accounting numbers will be less useful for contracting purposes.
JEL Classification: G39
Suggested Citation: Suggested Citation