Compensation Goals and Firm Performance

Abstract

Using a large dataset of performance goals employed in executive incentive contracts we find that a disproportionately large number of firms exceed their goals by a small margin as compared to the number that fall short of the goal by a similar margin. This asymmetry is particularly acute for earnings and profit goals, when compensation is contingent on a single goal and is present for both long-term and short-term goals, when the pay-for-performance relationship is concave or convex and for grants with cash or stock payout. Firms that exceed their compensation target by a small margin are more likely to beat the target the next period and CEOs of firms that miss their targets are more likely to experience a forced turnover. Firms that just exceed their EPS goals have higher abnormal accruals and lower Research and Development (R&D) expenditures and firms that just exceed their profit goals have lower SG&A expenditures. Overall, our results highlight some of the costs of linking managerial compensation to specific compensation targets.

JEL Classification: G30, J33