Beating the Target: Performance Management Around the Annual Incentive Target

Abstract

We document the propensity of Standard & Poor’s 500 index companies to just meet, rather than overshoot or just miss, performance targets in CEOs’ annual incentive plans to boost cash bonuses. The statistical anomaly occurs only in the 4th quarter and is robust to alternative assumptions of performance distribution, but disappears when we substitute historical trends or previous year’s performance targets for the targets. Moreover, boards of directors sometimes make further discretionary adjustments for the purpose of awarding incentive pay. We support Murphy and Jensen’s (2011) call to remove non-linearity in pay-performance relation and urge better disclosure to shareholders.

Keywords: Earnings management, Performance target, Annual incentive plan, Executive compensation

JEL Classification: G3, J31, J33