Enhanced Compensation Disclosure and Ex Post Discretionary Adjustments of Realized Performance in Executive Incentive Contracts

Abstract

ABSTRACT Recent research shows that the United States Securities and Exchange Commission’s enhanced compensation disclosures introduced in 2006 reduced boards’ flexibility in their compensation decisions and that boards immediately reacted by increasing executive pay to compensate for additional pay risk. We investigate firms’ longer-term reactions to these new disclosure rules. We find that firms often adjust realized earnings per share ex post when deciding their executives’ bonuses, and this practice has gained popularity since 2006. The use of ex post discretionary adjustments is more pronounced when boards’ demand for compensation flexibility is higher. Overall, our findings suggest that ex post discretionary adjustments are a source of flexibility that boards use to cope with limited compensation flexibility under the new compensation discussion and analysis disclosure rules. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M41; M52.