Properties of Accounting Performance Measures Used in Compensation Contracts

Abstract

This paper examines the properties of accounting numbers used in compensation contracts for S&P 500 firms from 2006 to 2017. Our data reveal wide variation in the accounting performance metrics used in compensation contracts, with some recent movement from bottom-line earnings-based measures to top-line measures. Investigating specific exclusions made to GAAP-based financial measures to arrive at realized compensation performances, we identify 27 different types of exclusions and document significant heterogeneity in tailoring across firms. We test whether exclusions are made to remove noise in performance measures and better isolate managerial effort (efficient contracting theory) or to camouflage managerial rent extraction (managerial power theory). We find evidence consistent with both explanations.

Keywords: Executive compensation, Accounting performance measure, Bonus contracts, Efficient contracting, Managerial power

JEL Classification: J33, M12, M41