Advances in Management Accounting

Laurie L. Burney, Mary A. Malina, Laurie L. Burney, Mary A. Malina

• Publisher: Emerald Publishing Limited
• Year: 2019
• ISBN:
  9781789732795
• Topic: Business
• Subtopic: Managerial Accounting
• Index: Business

Advances in Management Accounting (AIMA) is a publication of quality applied research in management accounting. The journal's purpose is to publish thought-provoking articles that advance knowledge in the management accounting discipline and are of interest to both academics and practitioners. As one of the premier management accounting research journals, AIMA is well-poised to meet the needs of management accounting scholars.
Featured in Volume 31 are articles on:
Competitor monitor and revenue management in hotels; The tie between CEO compensation and the 2008 financial crisis; The inclusion of qualitative measures in CEO incentive compensation; The association between performance-based pay and employee honesty; Managerial ability's linkage to earnings management within discontinued operations; Cash-to-cash and its association with long-term profitability in the manufacturing industry.

FIRM PERFORMANCE IMPLICATIONS OF USING QUALITATIVE CRITERIA IN CEO BONUS CONTRACTS

Ahmet C. Kurt and Nancy Chun Feng

ABSTRACT

Many argue that the design of compensation contracts for public company chief executive officers (CEOs) is often not guided by a goal of value maximization. Yet, there is limited direct empirical evidence on the negative consequences of the proposed inefficient contracting between shareholders and CEOs. Using data on CEO bonus contracts of the S&P 500 firms, we investigate potential firm performance implications of the use of qualitative criteria such as leadership and mentoring in those contracts. We maintain that unlike quantitative criteria, qualitative criteria are difficult to define and measure on an objective basis, possibly resulting in an inefficient and biased incentive structure. Twenty-five percent of the sample observations have CEO bonus contracts that include a qualitative criterion for bonus payment determination. Our results show that employee productivity, asset productivity, capital expenditures, and future abnormal stock returns are lower for firms that use a qualitative criterion in CEO bonus contracts than those that do not. Further, contrary to the argument in prior literature that earnings management decreases with the use of subjective performance indicators in incentive contracts, we find that income-increasing accruals are actually higher when the CEO bonus contract includes a qualitative criterion. We recommend that compensation committees set concrete, measurable performance goals for CEOs, providing CEOs with better guidance and helping improve their corporate decision making.

Keywords: Executive compensation; chief executive officers; bonus contracts; performance criteria; firm performance; earnings management

JEL classifications: G30; J33; M12; M41; M52

1. INTRODUCTION

Despite the importance of chief executive officer (CEO) performance evaluation for firm outcomes, there is no agreement in practice regarding the nature of performance criteria to be included in CEO compensation contracts (Angelis &Grinstein, 2014; Lipman & Hall, 2008; Murphy, 1999). Unlike quantitative criteria (e.g., net income, cash flows, market share), qualitative criteria such as displaying strong leadership, mentoring other executives, and implementing a strategic vision are used relatively less commonly perhaps because they are difficult to define and measure on an objective basis.

In fact, a recent CEO performance evaluation survey by HayGroup (2015, p. 22) highlights “a possible trend toward overreliance on easily quantifiable metrics, to the detriment of other qualitative aspects of performance.”¹ This trend is puzzling because theory suggests that an optimal bonus contract should include a qualitative assessment to supplement quantitative performance measures (e.g., Baker, Gibbons, & Murphy, 1994). To shed light on this issue, we investigate the firm performance implications of the use of qualitative criteria in CEO bonus contracts. In doing so, we aim to further understanding of the link between executive compensation contract design and firm performance. Our work complements and extends previous research focusing on the roots of subjectivity in CEO bonus contracts (e.g., Bushman, Indjejikian, & Smith, 1996; Höppe & Moers, 2011; Ittner, Larcker, & Ragan, 1997; Schiehll & Bellavance, 2009).

Our goal is to examine the consequences of the qualitative versus quantitative nature of the performance criteria included in CEO bonus contracts (not the consequences of CEO bonus plan subjectivity as a broad concept). We acknowledge that the use of qualitative criteria in CEO bonus contracts captures one aspect of the subjectivity embedded in such contracts. That is, CEO bonus contracts and performance evaluation become more subjective when companies rely on qualitative criteria in addition to quantitative metrics in determining CEO bonus payments. The level of subjectivity in CEO bonus payments is, of course, influenced by other factors such as the amount of bonuses paid at the discretion of the board of directors and whether bonus payments are calculated based on a preset formula. Our focus is specifically on the use of qualitative performance criteria such as leadership, other interpersonal skills, and strategic implementations, which have attracted significant attention from practitioners, consultants, and academics from various disciplines (e.g., Aiken & Keller, 2007; Donatiello, Larcker, & Tayan, 2017; Groysberg & Connolly, 2013; Harris & Helfat, 1997; Tosi, Misangyi, Fanelli, Waldman, & Yammarino, 2004; Trapp, 2016; Waldman, Ramirez, House, & Pura...

Table of contents

• Cover
• Title
• Competitor Monitoring and Revenue Performance: Evidence from the Hospitality Industry
• An Empirical Examination of Economic Determinants of Financial CEO Compensation: A Comparative Study on Pre- and Post-Financial Crisis Periods
• Firm Performance Implications of Using Qualitative Criteria in CEO Bonus Contracts
• Performance-Based Pay, Performance Monitoring, and Dishonest Behavior: The Plot Thickens
• The Role of Managerial Ability in Classification Shifting Using Discontinued Operations
• Cash-to-Cash (C2C) Length: Insights on Present and Future Profitability and Liquidity