The Effect of Restructuring Charges on Executives' Cash Compensation

Accounting Review, Vol. 69, No. 1 (January 1994), pp. 138-156

University of Alberta School of Business Research Paper No. 2013-212

Posted: 26 May 2013 Last revised: 30 May 2013

See all articles by Patricia M. Dechow

Patricia M. Dechow

University of Southern California - Leventhal School of Accounting; University of California, Berkeley - Accounting Group

Mark R. Huson

University of Alberta - Department of Finance and Statistical Analysis

Richard G. Sloan

University of Southern California - Leventhal School of Accounting

Date Written: January 23, 1993

Abstract

Top executives' compensation contracts typically provide for annual incentive awards that link executives' cash compensation and reported earnings. This link has been confirmed empirically by Lambert and Larcker (1987), who document a positive association between the cash compensation of chief executive officers (CEOs) and their firms' contemporaneous earnings performance. The widespread use of earnings-based incentives has prompted concerns that executives may select real decisions and accounting procedures to maximize their earnings-based compensation, irrespective of the impact on the economic well-being of the firm (Kaplan and Atkinson 1989, 724; Watts and Zimmerman 1986, 204). These concerns presume that the earnings-based performance measures specified in compensation contracts are strictly adhered to in setting executive compensation. In practice, however, these plans are administered by compensation committees, who could adjust compensation to prevent executives rom engaging in opportunistic behavior. Existing research provides mixed evidence as to whether compensation committees adjust earnings-based compensation. For example, Abdel-khalik (1985) finds evidence that CEO compensation is adjusted in response to accounting procedure changes. In contrast, Healy et al. (1987) find no evidence that CEO compensation is adjusted forthe effects of accounting procedure changes on reported earnings. This study provides evidence suggesting that compensation committees do adjust earnings-based incentive compensation. It documents reliable and systematic evidence that CEOs' cash compensation is adjusted for restructuring charges. between 1982 and 1989. The short-term incentive plans of the sample firms do not include explicit provisions for restructuring charges to be excluded from the definition of earnings used to determine executives' incentive compensation. The empirical analysis, however, indicates that CEO cash compensation is shielded from restructuring charges relative to other components of earnings. The results also suggest that the degree to which executive compensation is adjusted for a restructuring charge depends on the characteristics of the restructuring. Our evidence is consistent with the hypothesis that compensation committees systematically override the provisions of incentive plans to avoid providing executives with incentives to behave opportunistically. Restructurings typically require a large charge to earnings but can have a positive impact on the economic well-being of a firm. By adjusting executive compensation for restructuring charges, the compensation committee ensures that executives are not deterred from undertaking value-enhancing restructurings.

Keywords: Compensation committee, Executive compensation, Restructuring charge

Suggested Citation

Dechow, Patricia M. and Huson, Mark R. and Sloan, Richard G., The Effect of Restructuring Charges on Executives' Cash Compensation (January 23, 1993). Accounting Review, Vol. 69, No. 1 (January 1994), pp. 138-156; University of Alberta School of Business Research Paper No. 2013-212. Available at SSRN: https://ssrn.com/abstract=2269115

Patricia M. Dechow

University of Southern California - Leventhal School of Accounting ( email )

Los Angeles, CA 90089-0441
United States

University of California, Berkeley - Accounting Group ( email )

Haas School of Business
Berkeley, CA 94720
United States

Mark R. Huson (Contact Author)

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)

Richard G. Sloan

University of Southern California - Leventhal School of Accounting ( email )

Los Angeles, CA 90089-0441
United States

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