Managing Earnings Management: Compensation Committees’ Treatment of Earnings Components in CEOs’ Terminal Years*

Posted: 27 Aug 2009 Last revised: 27 Jan 2013

See all articles by Mark R. Huson

Mark R. Huson

University of Alberta - Department of Finance and Statistical Analysis

Yao Tian

San Jose State University

Christine I. Wiedman

University of Waterloo

Heather A. Wier

University of Alberta - Department of Accounting, Operations & Information Systems

Date Written: August 26, 2009

Abstract

The incentive to manipulate earnings to enhance earnings-based compensation increases in managers’ terminal years. We examine this horizon problem by considering the role of the compensation committee in setting terminal-year compensation. We predict that compensation committees are aware of the horizon problem and intervene when setting pay in terminal years. We find that the relation between changes in cash compensation and discretionary accruals changes is significantly reduced in the terminal years. This relation is symmetric for both positive and negative accrual changes. We also find weak evidence that the compensation committee views discretionary spending as less desirable as the CEO approaches retirement. Finally, we document that the relation between the level of option pay and the level of discretionary accruals is reduced in the terminal years. Our findings suggest that compensation committees do not act naively when setting CEO compensation in the terminal period and provide an explanation for the limited evidence of accounting manipulation in CEOs’ terminal years.

Keywords: horizon problem, compensation committee, discretionary accruals, real activity management

JEL Classification: M41, J33

Suggested Citation

Huson, Mark R. and Tian, Yao and Wiedman, Christine I. and Wier, Heather A., Managing Earnings Management: Compensation Committees’ Treatment of Earnings Components in CEOs’ Terminal Years* (August 26, 2009). Available at SSRN: https://ssrn.com/abstract=1461932

Mark R. Huson

University of Alberta - Department of Finance and Statistical Analysis ( email )

4-20C Business
University of Alberta
Edmonton, Alberta T6G 2R6
Canada
780-492-2803 (Phone)
780-492-3325 (Fax)

Yao Tian (Contact Author)

San Jose State University ( email )

San Jose, CA 95192-0066
United States
6505268206 (Phone)

Heather A. Wier

University of Alberta - Department of Accounting, Operations & Information Systems ( email )

Edmonton, Alberta T6G 2R6
Canada
780-492-3053 (Phone)
780-420-3325 (Fax)

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