Cost Shielding in Executive Bonus Plans

80 Pages Posted: 21 Feb 2020 Last revised: 4 Mar 2021

See all articles by Matthew J. Bloomfield

Matthew J. Bloomfield

The Wharton School of the University of Pennsylvania

Brandon Gipper

Stanford University Graduate School of Business

John D. Kepler

Stanford Graduate School of Business

David Tsui

University of Southern California - Marshall School of Business

Date Written: February 26, 2021

Abstract

Executive bonus plans often incorporate performance measures that exclude particular costs—a practice we refer to as “cost shielding.” We predict that boards use cost shielding to mitigate underinvestment and insulate new managers from the costs of prior executives’ decisions. We find evidence that boards use cost shielding to deter underinvestment in intangibles and encourage managers to take advantage of growth opportunities. We also find that cost shielding tends to be elevated for newly-hired executives, and decreases over tenure. Collectively, our results suggest that boards deliberately choose performance metrics that alleviate agency conflicts.

Keywords: executive compensation, cost shielding, managerial incentives, performance measurement, bonus contracts, agency theory

JEL Classification: G34, J3, M12

Suggested Citation

Bloomfield, Matthew J. and Gipper, Brandon and Kepler, John and Tsui, David, Cost Shielding in Executive Bonus Plans (February 26, 2021). Journal of Accounting & Economics (JAE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=3525148 or http://dx.doi.org/10.2139/ssrn.3525148

Matthew J. Bloomfield

The Wharton School of the University of Pennsylvania ( email )

1325 Steinberg-Dietrich Hall
3620 Locust Walk
Philadelphia, PA PA 19103-1724
United States
6073513042 (Phone)
6073513042 (Fax)

Brandon Gipper

Stanford University Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
(650)498-4350 (Phone)

John Kepler

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

David Tsui (Contact Author)

University of Southern California - Marshall School of Business ( email )

3660 Trousdale Parkway
Los Angeles, CA 90089
United States

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