CEO Compensation Risk and Timely Loss Recognition

33 Pages Posted: 26 Feb 2015

See all articles by Paul Brockman

Paul Brockman

Lehigh University - College of Business

Tao Ma

Texas Tech University

Jianfang Ye

Shanghai University of Finance and Economics - School of Accountancy

Date Written: January/February 2015

Abstract

Prior studies demonstrate that high CEO compensation risk encourages managers to engage in risk‐seeking behavior, thus intensifying agency conflicts between creditors and borrowers. We argue and document that accounting conservatism plays an important role in mitigating debt holder and shareholder conflicts over asset substitution arising from high CEO compensation risk. Our empirical results show that firms with high CEO compensation risk tend to use more timely loss recognition and this positive relationship is more pronounced for firms with high leverage. Additional results show that the positive relationship between CEO compensation risk and borrowing costs is reduced for firms using timely loss recognition, suggesting that creditors perceive timely loss recognition as a risk‐reducing mechanism. Using the passage of FAS 123R as a quasi‐natural experiment on managerial compensation risk, we find a significant reduction in the use of timely loss recognition for firms experiencing a decrease in CEO compensation risk after the passage of FAS 123R. Lastly, we show that timely loss recognition is positively associated only with the compensation risk of the firm's primary decision maker (i.e., its CEO) and not with the compensation risk of subordinates.

Keywords: CEO compensation risk, timely loss recognition, accounting conservatism, asset substitution

Suggested Citation

Brockman, Paul and Ma, Tao and Ye, Jianfang, CEO Compensation Risk and Timely Loss Recognition (January/February 2015). Journal of Business Finance & Accounting, Vol. 42, Issue 1-2, pp. 204-236, 2015. Available at SSRN: https://ssrn.com/abstract=2570631 or http://dx.doi.org/10.1111/jbfa.12100

Paul Brockman

Lehigh University - College of Business ( email )

Bethlehem, PA 18015
United States

Tao Ma

Texas Tech University ( email )

Box 42101
Lubbock, TX 79409-2101
United States

Jianfang Ye (Contact Author)

Shanghai University of Finance and Economics - School of Accountancy ( email )

No. 777 Guoding Road, Shanghai
Shanghai, 200433
China

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