Earnings-Based Bonus Plans and Earnings Management by Business Unit Managers

Posted: 31 Mar 1997

See all articles by Flora Guidry

Flora Guidry

University of New Hampshire - Whittemore School of Business and Economics

Andrew J. Leone

University of Miami

Steve Rock

University of Colorado at Boulder - Department of Accounting

Date Written: January 1997

Abstract

This study tests the Fixed-Target Hypothesis (Healy, 1985), wherein it is hypothesized that managers make discretionary accrual decisions to maximize their short-term bonuses. We conduct our analysis using business unit-level rather than firm-level data. In our setting, business unit manager incentive compensation is based solely on business unit earnings. Therefore, the potentially confounding effects of long-term performance and stock-based incentive compensation present in previous research are absent. Using multiple measures of discretionary accruals, we find evidence consistent with Healy (1985) in that managers with bonus- related incentives to make income-increasing discretionary accruals do so relative to managers with incentives to use accrual discretion to decrease earnings. To the extent that external financial reporting represents an aggregation of business unit financial reports, our results highlight the importance of internal contracting as a determinant of external reporting, as conjectured by Watts and Zimmerman (1990).

JEL Classification: M41, M43, M46, J33

Suggested Citation

Guidry, Flora and Leone, Andrew J. and Rock, Steven Karl, Earnings-Based Bonus Plans and Earnings Management by Business Unit Managers (January 1997). Available at SSRN: https://ssrn.com/abstract=2929

Flora Guidry

University of New Hampshire - Whittemore School of Business and Economics ( email )

15 College Road
Durham, NH 03824
United States

Andrew J. Leone (Contact Author)

University of Miami ( email )

School of Business
Coral Gables, FL 33146
United States
305-284-3101 (Phone)

HOME PAGE: http://sbaleone.bus.miami.edu

Steven Karl Rock

University of Colorado at Boulder - Department of Accounting ( email )

419 UCB
Boulder, CO 80309-0419
United States
303-735-5009 (Phone)
303-492-5962 (Fax)

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