Accounting for Net Performance in Managerial Compensation Contracts

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

Shane S. Dikolli

Duke University - Fuqua School of Business

Christian Hofmann

Ludwig Maximilian University of Munich - 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 S. 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)

Duke University - Fuqua School of Business ( email )

100 Fuqua Drive
Box 90120
Durham, NC 27708-0120
United States
919-660-1949 (Phone)
919-869-1901 (Fax)

Christian Hofmann

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

Kaulbachstr. 45
Munich, 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)

Paper statistics

Downloads
327
Rank
74,632
Abstract Views
1,571