Firm Performance Implications of Using Qualitative Criteria in CEO Bonus Contracts

Advances in Management Accounting, Vol 31, pp. 55-89, 2019

51 Pages Posted: 29 Nov 2017 Last revised: 27 Jul 2020

See all articles by Nancy Chun Feng

Nancy Chun Feng

Suffolk University

Ahmet C. Kurt

Bentley University - Department of Accountancy

Date Written: December 28, 2018

Abstract

Many argue that the design of compensation contracts for public company chief executive officers (CEOs) is often not guided by a goal of value maximization. Yet, there is limited direct empirical evidence on the negative consequences of the proposed inefficient contracting between shareholders and CEOs. Using data on CEO bonus contracts of the S&P 500 firms, we investigate potential firm performance implications of the use of qualitative criteria such as leadership and mentoring in those contracts. We maintain that unlike quantitative criteria, qualitative criteria are difficult to define and measure on an objective basis, possibly resulting in an inefficient and biased incentive structure. Twenty-five percent of the sample observations have CEO bonus contracts that include a qualitative criterion for bonus payment determination. Our results show that employee productivity, asset productivity, capital expenditures, and future abnormal stock returns are lower for firms that use a qualitative criterion in CEO bonus contracts than those that do not. Further, contrary to the argument in prior literature that earnings management decreases with the use of subjective performance indicators in incentive contracts, we find that income-increasing accruals are actually higher when the CEO bonus contract includes a qualitative criterion. We recommend that compensation committees set concrete, measurable performance goals for CEOs, providing CEOs with better guidance and helping improve their corporate decision making.

Keywords: Executive Compensation, Chief Executive Officers, Bonus Contracts, Performance Criteria, Firm Performance, Earnings Management

JEL Classification: G30, J33, M12, M41, M52

Suggested Citation

Feng, Nancy Chun and Kurt, Ahmet C., Firm Performance Implications of Using Qualitative Criteria in CEO Bonus Contracts (December 28, 2018). Advances in Management Accounting, Vol 31, pp. 55-89, 2019, Available at SSRN: https://ssrn.com/abstract=3077142 or http://dx.doi.org/10.2139/ssrn.3077142

Nancy Chun Feng

Suffolk University ( email )

120 Tremont St
Boston, MA 02108
United States
617-573-8719 (Phone)

Ahmet C. Kurt (Contact Author)

Bentley University - Department of Accountancy ( email )

175 Forest Street
Waltham, MA 02452
United States

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