Compensation Committees’ Treatment of Earnings Components in CEOs’ Terminal Years

Posted: 14 Oct 2011

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

Multiple version iconThere are 2 versions of this paper

Date Written: October 13, 2011

Abstract

Compensation committees face special difficulties when setting pay in the last years of a CEO’s tenure. For example, incentives to manipulate earnings for the purpose of enhancing earnings-based compensation are greater in CEOs’ terminal years. We predict that compensation committees are aware of these incentives and adjust the relative weights placed on earnings components in the cash compensation function to mitigate the problem. Consistent with our prediction, we find that, in CEOs’ terminal years, positive changes in discretionary accruals receive significantly less weight than other income components in determining cash compensation. This provides new evidence that not all gains flow through to compensation. We also find that, in non-terminal years, managers’ compensation is partially shielded from the negative effects of SG&A expenditures, but this effect reverses in the terminal period, consistent with the compensation committee discouraging investment in legacy assets by outgoing CEOs. Overall, our findings suggest that compensation committees treat components of earnings differently when setting pay in the terminal period.

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., Compensation Committees’ Treatment of Earnings Components in CEOs’ Terminal Years (October 13, 2011). Accounting Review, Vol. 87, No. 1, January 2012. Available at SSRN: https://ssrn.com/abstract=1943760

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

San Jose State University ( email )

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

Heather A. Wier (Contact Author)

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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