The impact of top management team incentive dispersion on Non-GAAP reporting

Abstract

We examine whether the dispersion of pay-performance sensitivity (PPS) amongst the top management team (TMT) impacts the likelihood of firms disclosing non-GAAP earnings and the
quality of non-GAAP earnings. Management compensation contracts are designed to incentivize
executive team members individually and in the aggregate. By structuring these contracts to
have similar PPS, those charged with governance can increase collaboration amongst the TMT.
However, this collaboration can turn into the TMT colluding to make firm decisions that result
in the highest compensation for the TMT. Thus, a greater dispersion of PPS can lead to less collusion. We find that the likelihood of firms reporting non-GAAP earnings decreases and the quality of non-GAAP earnings disclosures increases when there is a higher dispersion of PPS. These findings are consistent with executives that are less incentivized by temporary stock price increases suppressing other executives from eliciting firm scrutiny by disclosing non-GAAP earnings and releasing low-quality non-GAAP earnings. Additionally, we find these effects on non-GAAP earnings are more likely to occur in firms with weaker governance and when the management team has a shorter tenure of working together. Overall, our research provides evidence of the association between the dispersion of TMT PPS and non-GAAP earnings decisions.

Keywords: non-GAAP reporting, Earnings persistence, Top management team incentive dispersion, Executive compensation, Pay-performance sensitivity, Corporate governance