Accounting for Net Performance in Managerial Compensation Contracts

42 Pages Posted: 17 Aug 2011 Last revised: 6 Mar 2012

See all articles by Shane S. Dikolli

Shane S. Dikolli

Darden School of Business University of Virginia

Christian Hofmann

Ludwig Maximilian University of Munich (LMU) - Faculty of Business Administration (Munich School of Management)

Thomas Pfeiffer

University of Vienna - Accounting and Control

Date Written: March 5, 2012

Abstract

Prior empirical compensation studies typically consider net performance (i.e., measured after deducting compensation) while related principal-agent theory is generally based on gross performance measures (i.e., before compensation). We analyze incentive rates in a principal-agent model based on net (and gross) performance. We analytically demonstrate that using gross performance in compensation regressions yields an unbiased estimate of total effort incentives irrespective of whether actual compensation is based on net or gross performance. In contrast, using net performance creates a bias in estimating total effort incentives and yields a non-zero benchmark in testing for the strong-form relative performance evaluation hypothesis. We provide empirical evidence of underestimated total effort incentives when using net performance in compensation regressions, suggesting a possible explanation for surprisingly weak CEO incentives interpreted in prior studies.

Keywords: Executive Compensation, Relative Performance Evaluation, Performance Measurement

JEL Classification: J33, M40, M46

Suggested Citation

Dikolli, Shane Sami and Hofmann, Christian and Pfeiffer, Thomas, Accounting for Net Performance in Managerial Compensation Contracts (March 5, 2012). AAA 2012 Management Accounting Section (MAS) Meeting Paper. Available at SSRN: https://ssrn.com/abstract=1910819 or http://dx.doi.org/10.2139/ssrn.1910819

Shane Sami Dikolli (Contact Author)

Darden School of Business University of Virginia ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
4342431018 (Phone)

Christian Hofmann

Ludwig Maximilian University of Munich (LMU) - Faculty of Business Administration (Munich School of Management) ( email )

Kaulbachstr. 45
Munich, DE 80539
Germany

Thomas Pfeiffer

University of Vienna - Accounting and Control ( email )

Bruenner Strasse 72
Vienna 1210, Vienna
Austria
+43-1-4277-38002 (Phone)
+43-1-4277-38004 (Fax)

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