Impact of Economic Cycles on the Use of Performance Measures in Executive Compensation: An Empirical Examination

Abstract

An extensive body of literature documents the central role played by management accountants in the development of performance measures. However, little research exists on the temporal evolution of performance measures in response to changes in the macroeconomic environment. This study examines the impact of economic cycles on the use of sales and income, two widely used performance measures, in executive compensation. We find that during normal periods income receives greater weight than sales in the Chief Executive Officer (CEO) compensation. When recession strikes firms reduce the weight on income but not on sales, resulting in an increase in relative weight on sales. Further investigations reveal that the cross-sectional variations in the weight on sales and income are conditioned by the life cycle stage of the firm. Growth and mature firms assign more weight to income during normal times and also reduce the weight on income most during recessionary period. In contrast, introductory firms increase weight on sales while decline firms leave weights on sales and income unchanged during recession. We also analyze the compensation of the Chief Sales Officer (CSO). Our results indicate that during normal periods both sales and income receive equal weight. However, during a recession the weight on sales rises significantly while the weight on income falls significantly. These findings indicate that the firms dynamically adjust the weights on sales and income in response to phases of economic cycles. To our knowledge, this is the first study to look at the impact of recession on the use of sales and income performance measures in executive compensation.

Keywords: Executive Compensation, Economic Cycles, Firm Life Cycle, Sales, Income.