The Role of Stock Returns in CEO Performance Evaluation: A New Interpretation

74 Pages Posted: 19 Jan 2021 Last revised: 18 Aug 2021

See all articles by Sudarshan Jayaraman

Sudarshan Jayaraman

University of Rochester - Simon Business School; Simon Business School, University of Rochester

Xiaoxu Ling

Hong Kong Polytechnic University - School of Accounting and Finance

Joanna S. Wu

University of Rochester - Simon Business School

Yong Zhang

Hong Kong Polytechnic University

Date Written: August 15, 2021

Abstract

It has been well-established that both stock prices and accounting earnings are used to evaluate and compensate CEOs. Prior studies often interpret the higher sensitivity of compensation revisions to stock prices (relative to accounting earnings) as the superior role of price formation versus financial reporting in conveying information about CEO effort. Using an information perspective that parses out firm-initiated news events during the year when stock prices impound the future implications of the information released in these events, we show that a significant part of the explanatory power of stock returns for CEO compensation occurs during trading days when financial accounting information is publicly released to the market. Further, the greater pay-for-performance sensitivity of information-event returns for CEO compensation is pronounced for events that are informative about CEO effort and especially those that are associated with accounting disclosures. Additional cross-sectional tests based on shocks to auditor reputation, internal control weaknesses, and large shareholder attention demonstrate the role of financial reporting credibility and corporate governance in our inferences. Overall, our study illustrates the co-dependence between price-based and accounting-based measures for CEO performance evaluation, and presents a framework that exploits this complementarity.

Keywords: Executive compensation; Pay-performance sensitivity; Accounting performance

JEL Classification: J33, M41

Suggested Citation

Jayaraman, Sudarshan and Jayaraman, Sudarshan and Ling, Xiaoxu and Wu, Joanna Shuang and Zhang, Yong, The Role of Stock Returns in CEO Performance Evaluation: A New Interpretation (August 15, 2021). Available at SSRN: https://ssrn.com/abstract=3754022 or http://dx.doi.org/10.2139/ssrn.3754022

Sudarshan Jayaraman

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States
585-275-3491 (Phone)

Simon Business School, University of Rochester ( email )

Rochester, NY 14627
United States
585-275-3491 (Phone)

Xiaoxu Ling

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

Joanna Shuang Wu (Contact Author)

University of Rochester - Simon Business School ( email )

Carol Simon Hall 3-160D
Rochester, NY 14627
United States
585-275-5468 (Phone)
585-442-6323 (Fax)

Yong Zhang

Hong Kong Polytechnic University ( email )

Hung Hom
Hung Hom
Kowloon, AK HK HK
Hong Kong

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