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Compensation Contracts (compensation + contract)
Selected AbstractsCorporate Investment Incentives and Accounting-Based Debt Covenants,CONTEMPORARY ACCOUNTING RESEARCH, Issue 4 2003Alan V. S. Douglas Abstract This paper studies the conditions under which accounting-based debt covenants increase firm value in a setting that incorporates the conflicting incentives of shareholders, bondholders, and managers. We construct a model in which debt is needed to discipline managerial investment decisions despite endogenous compensation contracts. We show that accounting covenants increase value when (1) debt serves as a credible commitment to penalize poor investment decisions; (2) the firm faces other (exogenous) sources of uncertainty that can make debt risky despite good investment decisions; and (3) accounting information serves as a contractible proxy for firm's economic performance. In these circumstances, accounting covenants ensure that shareholders do not offer compensation schemes that would encourage bondholder wealth expropriation when the debt becomes risky. A covenant specifying a required level of accounting performance provides additional bondholder power when performance is low. An accounting-based dividend covenant allows a disbursement to maintain investment incentives when performance is high without allowing dividend-based expropriation. The optimal covenants depend on the reliability of accounting information, and the interaction between accounting performance and the different incentive conflicts provides new insight into the empirical literature on accounting-based covenants. [source] The Subjective Valuation of Indexed Stock Options and Their Incentive EffectsFINANCIAL REVIEW, Issue 2 2006A. Louis Calvet G13; G12; J33; J32 Abstract We analyze the potential role of indexed stock options in future pay-for-performance executive compensation contracts. We present a unified framework for index-linked stock options, discuss their incentive effects, argue that indexation schemes based on the capital-asset pricing model (CAPM) are the most suitable for executive compensation, and derive a subjective pricing model for the class of CAPM-based indexed stock options. Contrary to earlier work, executives would not be motivated to take on investment projects with high idiosyncratic risk once their lack of wealth diversification and degree of risk aversion are factored into the analysis. [source] Dividend payout and executive compensation: theory and evidenceACCOUNTING & FINANCE, Issue 4 2008Nalinaksha Bhattacharyya G35; J38 Abstract Bhattacharyya (2007) develops a model in which compensation contracts motivate high-quality managers to retain and invest firm earnings, while low-quality managers are motivated to distribute income to shareholders. In equilibrium, the model shows that there is a positive (negative) relationship between the earnings retention ratio (dividend payout ratio) and managerial compensation. Results of tests of US data show that executive compensation is positively (negatively) associated with earnings retention (dividend payout). Our results indicate that corporate dividend policy is perhaps best understood by considering the payout ratio (dividends divided by earnings), rather than the level of cash dividends alone. [source] How Much New Information Is There in Earnings?JOURNAL OF ACCOUNTING RESEARCH, Issue 5 2008RAY BALL ABSTRACT We quantify the relative importance of earnings announcements in providing new information to the share market, using the R2 in a regression of securities' calendar-year returns on their four quarterly earnings-announcement "window" returns. The R2, which averages approximately 5% to 9%, measures the proportion of total information incorporated in share prices annually that is associated with earnings announcements. We conclude that the average quarterly announcement is associated with approximately 1% to 2% of total annual information, thus providing a modest but not overwhelming amount of incremental information to the market. The results are consistent with the view that the primary economic role of reported earnings is not to provide timely new information to the share market. By inference, that role lies elsewhere, for example, in settling debt and compensation contracts and in disciplining prior information, including more timely managerial disclosures of information originating in the firm's accounting system. The relative informativeness of earnings announcements is a concave function of size. Increased information during earnings-announcement windows in recent years is due only in part to increased concurrent releases of management forecasts. There is no evidence of abnormal information arrival in the weeks surrounding earnings announcements. Substantial information is released in management forecasts and in analyst forecast revisions prior (but not subsequent) to earnings announcements. [source] Nonfinancial Performance Measures and Promotion-Based IncentivesJOURNAL OF ACCOUNTING RESEARCH, Issue 2 2008DENNIS CAMPBELL ABSTRACT In this paper, I examine the sensitivity of promotion and demotion decisions for lower-level managers to financial and nonfinancial measures of their performance and investigate the extent to which the behavior of lower-level managers reflects promotion-based incentives. Additionally, I test for learning versus effort-allocation effects of promotion-based incentives. I find that promotion and demotion decisions for store managers of a major U.S.-based fast-food retailer (QSR) are sensitive to nonfinancial performance measures of service quality and employee retention after controlling for financial performance. The likelihood of demotion in this organization is also sensitive to nonfinancial performance on the dimension of service quality, while the probability of exit is primarily sensitive to financial performance measures rather than nonfinancial performance measures. I also find evidence that the behavior of lower-level managers is consistent with the incentives created by the weighting of nonfinancial performance measures in promotion decisions. Managers in locations where there is a higher ex ante probability of promotion and a higher potential reward upon promotion demonstrate significantly higher levels and rates of performance improvement in service quality. Finally, consistent with promotion-based incentives inducing both effort-allocation and learning effects, I find that performance-improvement rates for service quality: (1) are higher in prepromotion periods in markets where promotions occur, (2) decrease immediately after the occurrence of a promotion in the same market area, and (3) remain higher than in markets where promotions do not occur. These findings provide some of the first empirical evidence on an alternative to the explicit weighting of nonfinancial metrics in compensation contracts as a mechanism for generating improvements in nonfinancial dimensions of performance. [source] An Analysis of the Relation between the Stewardship and Valuation Roles of EarningsJOURNAL OF ACCOUNTING RESEARCH, Issue 1 2006ROBERT BUSHMAN ABSTRACT In this paper, we seek a deeper understanding of how accounting information is used for valuation and incentive contracting purposes. We explore linkages between weights on earnings in compensation contracts and in stock price formation. A distinction between the valuation and incentive contracting roles of earnings in Paul [1992] produces the null hypothesis that valuation earnings coefficients (VECs) and compensation earnings coefficients (CECs) are unrelated. Our empirical analyses of the relations between earnings and both stock prices and executive compensation data at the firm and industry levels over the period 1971,2000 rejects Paul's [1992] hypothesis of no relation. We also document an increasing weight over time on other public performance information captured by stock returns in the determination of cash compensation. Specifically, we find that the incentive coefficient on returns is significantly higher in the second of two equal sample subperiods relative to the incentive coefficient on earnings. [source] FREE CASH FLOW AND PUBLIC GOVERNANCE: THE CASE OF ALASKAJOURNAL OF APPLIED CORPORATE FINANCE, Issue 3 2000Dwight R. Lee In a widely cited 1986 article in the American Economic Review, Michael Jensen gave the concept of free cash flow (FCF) a new twist by redefining it as cash flow in excess of that required to fund all projects with positive net present values. Put another way, FCF represents funds available in the firm that managers may choose to hold as idle cash, return to shareholders, or invest in projects with returns below the firm's cost of capital. In redefining FCF in this way, Jensen converted FCF from a measure of economic income and value into a measure of corporate assets available for discretionary, and potentially value-destroying, use by firm managers. And, as he argued in his important article, managers in mature businesses with substantial free cash flow have a tendency to destroy value by plowing too much capital back into those businesses or, often worse, making ill-advised acquisitions in unrelated businesses. Several methods have been developed in financial markets and internal corporate governance systems to discourage managers from wasting FCF. Better monitoring by boards of directors, large ownership blocks, and properly aligned management compensation contracts are all parts of the solution. And the extraordinary increase in stock repurchases in recent years, invariably applauded by investors, is another illustration of the market's success in encouraging companies to address their free cash flow problems. But if the "FCF problem" of the private sector has attracted considerable attention from finance scholars, the problem is even more acute in the public sector, where FCF can be thought of as tax revenue in excess of what is required to finance well-defined and generally accepted levels of public services. Unlike the private sector, in the public sector there are neither measures nor mechanisms by which to monitor and constrain wasteful spending by elected officials. In this article, the authors attempt to measure the costs to taxpayers of government FCF using the case of Alaska, which since 1969 has received a huge windfall of tax revenue from North Slope oil leases. After examining the state's public finances from 1968 through 1993, the authors offer $25 billion as a conservative estimate of the social losses from Alaska's waste of free cash flow during that 25-year period. [source] | ||||||||||