Cost Shielding in Executive Bonus Plans

62 Pages Posted: 21 Feb 2020

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: January 24, 2020

Abstract

Executive bonus plans often incorporate performance measures that disregard certain costs — a phenomenon we refer to as “cost shielding.” We develop measures of cost shielding and examine whether boards use cost shielding to alleviate agency conflicts between executives and shareholders. Consistent with predictions from agency theory, we find that boards select performance measures to shield executives from costs that are (i) incurred prior to their associated benefits, or (ii) the result of previous executives’ actions. We also find that many of these patterns are more pronounced among firms with more financial expertise on the board. Collectively, our results provide evidence that boards use cost shielding in executive bonus plans in response to potential agency conflicts and suggest that directors’ financial expertise facilitates incentive-compensation contracting efficiency.

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 (January 24, 2020). 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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