CEO Incentives and Earnings Management
What happened with stock based and option based executive compensation in the past years?
They increased (tippled between 1980 and 1994 & doubled between 1994 and 2000)
What are efficient contracts?
One that maximises net expected economic value to shareholders after transaction costs and payment to employees.
Define Clawback Provision.
Allows firms to recoup compensation from executives open the occurrence of a predefined trigger event.
Explain the Alignment Category.
Accepting the 1$ Salary to align personal interests with shareholders interest.
What are the non-financial performance measures?
Ex. market share, productivity, efficiency, product quality, customer satisfaction, employee satisfaction.
What is earnings management?
Describes the manipulation of financial records to mislead stakeholders.
Did optimal contracting arrangements change in the past?
Yes, they evolve with changes in contracting technology
Explain the two types of clawback provision.
(1) Robust Clawback - requires repayment regardless of the cost
(2) Misconduct Clawback - requires repayment only when intentionally misconduct is involved
Explain the Downturn Category.
Accepting 1$ Salary to show sacrifice during a downturn or crisis.
Why do CEO Bonus Contracts include performance measures?
Because it has a long history with rewarding by the means of financial metrics.
What are discretionary accruals?
Non - obligatory expense (ex. bonus) that is yet to be realised but already recorded in the account books.
Which type of firm uses stock options more?
High - technology "new - economy" firms.
Why did clawback provision gain much in popularity over the past decade?
Because of financial reporting failures and financial crisis.
What do critics of the 1$ Salary argue?
The CEO's are still paid millions in stock & options.
Innovative - oriented firms with a "prospector strategy" rather that cost leaders or firms with a "defender strategy."
Which adverse incentives are associates with a high sensitivity of CEO pay to stock options?
Increased compensation based on stock options may lead to an increased incentive to manipulate accounting records.
How do the authors see the effectiveness of executive compensation?
Even though there are opposing views on effectiveness of contracts, authors believe compensation contracts minimise agency costs and are therefore effective.
Which type of clawback provision has a larger impact on financial reporting quality?
Robust clawback provision as it is stricter.
When is a CEO more likely to accept 1$ Salary in the Alignment Category.
If the CEO is also the chairman --> more insights, therefore acceptance is a sign of good expected future performance
State the Hypothesis and explain which ones were supported.
H1: Non – financial measures may increase the efficiency in contracting with the manager. (TRUE)
H2: Non – financial measures may be used by powerful CEOs to increase compensation above level justified by the firms economic performance. (FALSE)
What happened at Xerox?
Xerox manipulated earnings and revenues and overstated revenues by almost 2 billions.
What are the determinants of equity based compensation?
(1) Firm size as bigger firms requite "more talented" managers
(2) Uncertain firm environment
Which type of clawback is triggered by the SOX and which by the Dodd-Frank Act?
SOX - only if misconduct
Dodd - Frank Act - clawback possible irrespective of misconduct
What effect does accepting the 1$ Salary in a crisis have on the CEO's job security.
Accepting the salary leads to a prolonged tenure by 1 1/2 years.
Which factors do the authors expect to have an influence on the relative weight placed on financial and non-financial performance measures?
- Organisational Strategy
- Quality Strategy
- Regulation
- Financial Performance
- Exogenous Noise