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Firm Performance Implications of Using Qualitative Criteria in CEO Bonus Contracts

Advances in Management Accounting

ISBN: 978-1-78973-278-8, eISBN: 978-1-78973-277-1

ISSN: 1474-7871

Publication date: 16 July 2019

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.

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Acknowledgements

Acknowledgments

We thank the review team for their helpful comments and suggestions. We also thank Ana Albuquerque, Rani Hoitash, Udi Hoitash, Bill Johnson, Krishnagopal Menon, and seminar participants at Bentley University and Suffolk University for their feedback. Hin Fung Lau, Hieu Pham, Francesco Servidio, and Kimberly Tsang provided able research assistance. Ahmet Kurt acknowledges past research support from Northeastern University, where he was a visiting Assistant Professor in the Accounting and Finance Groups between 2012 and 2014.

Citation

Kurt, A.C. and Feng, N.C. (2019), "Firm Performance Implications of Using Qualitative Criteria in CEO Bonus Contracts", Burney, L.L. and Malina, M.A. (Ed.) Advances in Management Accounting (Advances in Management Accounting, Vol. 31), Emerald Publishing Limited, Bingley, pp. 55-89. https://doi.org/10.1108/S1474-787120190000031004

Publisher

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Emerald Publishing Limited

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