Adopting Residual Income-Based Compensation Plans: Evidence of Effects on Management Actions
Posted: 14 Apr 1997
Date Written: March 1997
It has been asserted that compensation plans based on a residual income performance measure help mitigate dysfunctional behavior associated with plans based on accounting earnings. This assertion is empirically tested by selecting a sample of firms that have begun using a residual income performance measure in their compensation plans and comparing their performance to a control sample of firms that continue to use traditional accounting earnings-based incentives. Relative to the control firms, these firms 1) decreased their new investment and increased their dispositions of assets, 2) increased their shareholder payouts, and 3) more efficiently used their assets. Further, evidence suggests that market participants respond favorably to adoption of residual income-based compensation plans. For the sample of firms studied, I interpret the results as being consistent with a residual income-based performance measure providing incentives for managers to act more like owners, thus mitigating the inherent conflict between managers and shareholders.
JEL Classification: M41, J33, G31, G35
Suggested Citation: Suggested Citation