Subjective Adjustments to Objective Performance Measures in Executive Annual Bonus Contracts

62 Pages Posted: 15 Aug 2017 Last revised: 15 May 2019

See all articles by Sunyoung Kim

Sunyoung Kim

Monash University

Jae Yong Shin

Seoul National University - College of Business Administration

Date Written: May 1, 2019

Abstract

We examine boards of directors’ subjective adjustments to objective performance measures in executive incentive contracts. Using a unique hand-collected sample of adjusted earnings per share measures used to determine executives’ annual bonuses, we provide large-sample evidence that subjective adjustments are related to uncontrollable noise, firms’ demand for congruity improvement, and the need to meet CEOs’ participation constraints. We also find that managers are more likely to meet or beat their performance targets when boards adjust their realized earnings. Finally, we find that the ex ante option to adjust mitigates managerial short-term focus more effectively than ex post adjustments. Overall, our findings suggest that boards use subjective adjustments to alleviate the limitations of formula-based incentive contracts.

Keywords: Subjectivity; Subjective adjustments; Objective measures; Executive annual bonuses

JEL Classification: M41; M52

Suggested Citation

Kim, Sunyoung and Shin, Jae Yong, Subjective Adjustments to Objective Performance Measures in Executive Annual Bonus Contracts (May 1, 2019). AAA 2018 Management Accounting Section (MAS) Meeting. Available at SSRN: https://ssrn.com/abstract=3018199 or http://dx.doi.org/10.2139/ssrn.3018199

Sunyoung Kim

Monash University ( email )

H3.43, Building H, Level 3
Monash University Caulfiled
Melbourne, VIC 3145
Australia
613 99032183 (Phone)

Jae Yong Shin (Contact Author)

Seoul National University - College of Business Administration ( email )

Seoul, 151-742
Korea, Republic of (South Korea)

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