Cost Shielding in Executive Bonus Plans
80 Pages Posted: 21 Feb 2020 Last revised: 4 Mar 2021
Date Written: February 26, 2021
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: Suggested Citation