Asymmetric sensitivity of executive bonus compensation to earnings and the effect of regulatory changes

Abstract

In this paper we examine the sensitivity of CEO bonus to earnings in the cases of good news and bad news, and compare these relationships in the periods before and after SOX. We find an asymmetric sensitivity of bonus to earnings. We also find that the asymmetric sensitivity of bonus to earnings exists before SOX but disappears post SOX. Regulatory changes brought forth by SOX, including personal certifications of financial reporting by CEOs and CFOs, the claw back provision, annual evaluation of internal controls and disclosure of any material weakness, and increased level of conservatism in firms and their auditors after SOX, offer an alternative mechanism to monitor executives, potentially reducing the ex post settling up problem. The findings show that regulatory changes affect compensation contracts and have implications for regulators, managers, politicians, investors, and academics in their assessment of the equitable relationship between executive efforts and executive bonus compensation.