Revenue-Expense Matching and Performance Measure Choice

Abstract

Recent research shows that matching between contemporaneous revenues and expenses has declined over the past 40 years. We argue that this decline in matching reduces the contracting usefulness of earnings and affects managerial effort allocation and performance measure choice. Based on a theoretical model, we predict that firms with poor matching benefit from contracting on sales revenue instead of earnings. Using hand-collected CEO performance measure data from S&P 500 firms, we document a significant increase in the use of sales revenue coupled with a significant decline in the use of bottom-line income as a performance measure over time. We confirm the model prediction that firms are more likely to explicitly employ sales revenue as a performance measure when matching is poor. We further show that this negative association between matching and the use of sales revenue performance persists after controlling for the use of other non-bottom-line earnings measures and equity compensation. This study contributes to the literature by examining the effect of revenue-expense matching on compensation design and documenting the increasing trend of revenue-based compensation in recent years.

Keywords: Matching Principle, Performance Measure, Compensation Contract.

JEL Classification: M41, J33