The use of non-financial performance measures in CEO compensation contracts and pricing of audit engagements: Evidence from the amendment to PCAOB AS 2110

This study examines the associations between top management’s interactive and diagnostic use of financial and non-financial performance measures with individual manager’s (i.e. middle and lower level managers) creativity, and the mediating role of middle and lower level manager’s perceived fairness of their performance appraisal on such associations. Using data from a survey of 220 middle and lower level managers from manufacturing organisations in Australia, the structural equation model revealed direct positive associations between both the diagnostic use of financial performance measures and the interactive use of non-financial performance measures with individual creativity. Further, the positive effect of the interactive use of financial performance measures on individual creativity is positively and fully mediated by distributive, interpersonal and informational fairness, while the positive effect of the interactive use of non-financial measures is positively and partially mediated by interpersonal and informational fairness. In addition, procedural fairness positively and partially mediates the effect of the diagnostic use of financial performance measures on individual creativity, and interpersonal fairness positively and fully mediates the effect of the diagnostic use of non-financial performance measures on individual creativity. The findings contribute to the performance measurement and appraisal literature examining the interactive and diagnostic use of both financial and non-financial performance measures and extends the sparse literature on the role of perceived fairness in explaining the behavioural effect of performance measurement systems. The findings also provide implications for practice, revealing the importance of the interactive and diagnostic use of financial and non-financial performance measures, and manager’s perception of the fairness of performance appraisal processes as a mechanism through which individual manager’s creativity can be enhanced.

ABSTRACTResearch Question/IssueThis study examines the association between ownership type—family versus nonfamily firms—and CEO family status—family CEO versus professional CEO—and the use of nonfinancial performance measures (NFPMs) in CEO compensation contracts.Research Findings/InsightsUsing a sample of 3143 firm‐year observations of S&P 500 nonfinancial firms from 2010 to 2018, we find that family firms place a significantly lower weight on NFPMs in CEO compensation contracts than nonfamily firms. Within family firms, we find that a significantly lower weight is placed on NFPMs in compensation contracts for family CEOs relative to those for professional CEOs. Furthermore, additional tests indicate that the negative association between family ownership and the weight placed on NFPMs is stronger (weaker) in firms with low (high) stakeholder visibility.Theoretical ImplicationsWe advance the academic literature on the selection of performance measures in compensation contracts by providing insight into the implications of family ownership and of a CEO's family ties for the use of NFPMs. The results suggest that because family firms have a good ability and a strong incentive to directly monitor and control their CEO's actions, NFPMs are less needed in CEO compensation contracts as a means to align goals. Furthermore, the effects we document are even stronger when the CEOs of family firms are family members.Practitioner/Policy ImplicationsThe results imply that while family firms may not need a high weight on NFPMs in CEO compensation contracts to monitor their CEOs' actions, goal alignment, and internal communication of nonfinancial targets, they may still need them for communication and signaling purposes when exposed to external stakeholder monitoring.

This study investigates whether and how board characteristics influence firms’ choice of incorporating non-financial performance measures (NFPM) in CEO compensation. The board of directors (BOD) is responsible for designing executive compensation. Outside directors of BOD can provide more objective monitoring considering their independent status (Fama and Jensen 1983), while inside directors have better access to inside information (Klein 1998; Adams and Ferreira 2007). The effectiveness of corporate governance can be a key factor in the choice of NFPM in CEO compensation contracts. Using two proxies, the percentage of director ownership and the value of director ownership, we find that firms with a higher proportion of outside board members are more likely to adopt NFPM. We also find a concave relation between the percentage of inside director shares and the use of NFPM. Specifically, boards with both a low and a high level of inside director ownership are more likely to recommend the use of NFPM. In addition, the probability of using NFPM is negatively associated with the value of inside director shares. This evidence suggests that entrenchment issues are a plausible disadvantage of offering equity incentives to board members. That is, directors become entrenched as their own wealth becomes increasingly tied to the firm and they begin to make decisions that may not be in the best interest of shareholders. The results of this study shed light on how the composition and remuneration of the BOD affects the design of firm compensation and the use of NFPM in particular.

This study empirically investigates firms' decisions to retain the use of nonfinancial performance measures as part of the compensation contracts following their initial implementation. Using three-stage regression and survival analysis, we provide explanations for the decision to retain the use of nonfinancial performance measures after controlling for possible endogeneity. Based on a sample of firms that used nonfinancial measures during the period 1993–1998, we find that the appropriate match of nonfinancial measures and firm characteristics and subsequent enhanced performance are crucial factors in deciding whether a firm will retain nonfinancial performance measures in compensation contracts. The analyses provide evidence that the effects of significant firm characteristics on the decision to retain nonfinancial performance measures are time invariant while the effects of performance are time variant during the study period. The results suggest that adverse performance is a reflection of a nonoptimizing initial adoption decision of nonfinancial performance measures while the decision to discard their use in light of the unfavorable performance is an indication of an optimizing decision.

O propósito principal deste estudo é investigar o relacionamento entre o uso de medidas não financeiras de desempenho e orientação temporal dos gestores ao examinar empiricamente predições normativas da contabilidade no que se refere ao relacionamento positivo entre o uso de medidas não financeiras de desempenho e orientação temporal dos gestores. Além disso, este estudo explora o efeito moderador da missão estratégica da empresa sobre o relacionamento entre o uso de medidas não financeiras de desempenho e orientação temporal dos gestores ao examinar se uma missão estratégica de longo prazo intensifica o relacionamento positivo entre medidas não financeiras de desempenho e orientação temporal dos gestores. Portanto, são desenvolvidas hipóteses referentes à associação entre o uso de medidas não financeiras e orientação temporal dos gestores, assim como, se estratégia modera esse relacionamento, tendo por base a literatura contábil relevante sobre o tema. Realiza-se um levantamento em que os questionários são enviados para o endereço eletrônico de uma amostra de gestores de nível intermediário atuando em empresas no Brasil. Utiliza-se a técnica estatística de mínimos quadrados parciais (PLS) e análise de subgrupos para testar as hipóteses de pesquisa. Os resultados indicam a presença de um relacionamento significativo entre uso de medidas não financeiras e orientação temporal dos gestores, mas, contrário às predições normativas e às expectativas deste estudo, uma orientação temporal mais de curto prazo está associada com uma maior importância relativa atribuída a medidas não financeiras de desempenho. Além disso, novamente contrário às expectativas deste estudo, os resultados indicam que a missão estratégica de uma empresa modera esse relacionamento da seguinte maneira: se perseguindo uma estratégia de construir, uso de medidas não financeiras de desempenho está negativamente relacionada com orientação temporal dos gestores. A principal implicação deste estudo é que podem existir certas situações em que o uso de medidas não financeiras de desempenho não contribui para a tomada de decisões de longo prazo. Pesquisa futura poderia explorar essas situações de modo que seja possível obter um entendimento mais amplo dos efeitos de diferentes medidas de desempenho sobre orientação temporal dos gestores.

The progress presentation

Evidence permeates the literature on the increasing use of non-financial performance measures in organisations. However, academics and researchers should be interested in considering the factors that affect managers' decisions to use non-financial performance measures in their organisations. This paper is a part of ongoing international research comparative studies aiming at exploring associations between the use and importance of Shop-Floor Non-Financial Performance Measures (SFNFPMs) in manufacturing firms and a range of technological, managerial, organisational and environmental factors. These comparative studies also aim at developing a framework for a causal SFNFPMs scorecard in work in manufacturing firms. The core issue of this paper is to present summary statistics of research responses from surveying over 1115 Japanese manufacturing firms as part of the ongoing international research studies. These summary statistics cover the level of existence and importance of some SFNFPMs in use in Japanese manufacturing firms and the level/extent of application of the above various factors.

Customer-focused manufacturing strategy and the use of operations-based non-financial performance measures: A research note

Purpose The widespread adoption of the Balanced Scorecard has led to a need to understand how performance measures affect employees’ attitudes and behaviors. Despite the growing trend in the implementation of the Balanced Scorecard, there is little research evidence available on the behavioral outcomes resulting from the use of nonfinancial performance measures. This study seeks to address this gap by examining several behavioral outcomes, including job satisfaction, organizational commitment and managerial performance, resulting from the use of financial and nonfinancial performance measures. Methodology Data were collected using a mailed questionnaire survey to manufacturing organizations in Singapore. Path analysis technique was employed in this study to investigate the relationships. Findings The results of the study show that behavioral outcomes are indifferent regardless of the nature and type of performance measures used. However, the relationships between performance measures and behavioral outcomes are indirect through procedural fairness and trust in supervisor. Research limitations Survey questionnaire method was used in this study and there are limitations associated with survey questionnaire method. As our sample was selected from large organizations, it is unclear if our results are generalizable to small organizations. Also, as our sample was selected from the manufacturing sector, generalizing our results to the nonmanufacturing sectors should be made with caution. Practical implications This study highlights the need for organizations to pay attention to issues pertaining to procedural fairness and interpersonal trust in the design and implementation of performance measurement systems.

This paper empirically examines the role of environmental uncertainty and corporate culture on the relationship between non-financial performance measures and organizational performance from manufacturing firms in Bangladesh. Specifically, it investigates the hypothesis that non-financial measures of performance lead to improved organizational performance under circumstances of increased environmental uncertainty and corporate culture. Data from a sample of 61 manufacturing firms listed on Dhaka Stock Exchange (DSE) in Bangladesh were collected. Data were then analyzed using multiple regression and factor analysis of multivariate statistical tool. Results show that there is a negative but statistically significant relationship regarding the impact of environmental uncertainty on the relationship between non-financial measures and firm performance. The results also advocate that sample Bangladeshi firms make greater use of non- financial measures with the aim of improving firm performance when environmental uncertainty is low. Conversely, the study finds positive relationship between flexibility type corporate culture and the organizational performance, and the moderating effect of this cultural type on the non-financial performance measures- organizational performance linkage. The results of this study must be interpreted with caution since it concentrates only on small sample manufacturing firms. To the best of our knowledge, the study is first to provide evidence on the environmental uncertainty and corporate culture affecting the use of non-financial performance measures and firms performance in the context of a developing country, in particular in Bangladesh.

ABSTRACT: This study utilizes a national survey of physicians in the United States, administered four times between 1996 and 2005, to examine the use of nonfinancial performance measures in physician compensation contracts. Consistent with agency theory, we find that nonfinancial measures are used more frequently when the measures are more informative; when alternative control mechanisms are complements rather than substitutes; and when external pressures for quality of care and cost containment are greater. Further, we find that contractual relationships in the health care value chain are interrelated; nonfinancial measures are more likely to be used to evaluate physician performance when the physicians’ practice is compensated based on fixed rate payments (i.e., capitation). We also find that physicians’ compensation contracts are more likely to incorporate nonfinancial performance measures when productivity in revenue generation is also used to evaluate performance. Taken together, the results suggest that nonfinancial performance measures play a significant role in physician compensation, acting to balance incentives tied to individual physician productivity.

This study utilizes a national survey of physicians in the United States, administered four times between 1996 and 2005, to examine the use of non-financial performance measures in physician compensation contracts. Consistent with agency theory, we find that non-financial measures are used more frequently when the measures are more informative, when alternative control mechanisms are complements rather than substitutes, and when external pressures for quality of care and cost-containment are greater. Further, we find that contractual relationships in the healthcare value chain are inter-related; non-financial measures are more likely to be used to evaluate physician performance when the physicians’ practice is compensated based on fixed rate payments (i.e., capitation). We also find that physicians’ compensation contracts are more likely to incorporate non-financial performance measures when productivity in revenue generation is also used to evaluate performance. Taken together, the results suggest that non-financial performance measures play a significant role in physician compensation, acting to balance incentives tied to individual physician productivity.

Extending the Boundaries: Nonfinancial Performance Measures

Research Question/IssueIn this study, we explore the relationship between the use of nonfinancial performance measures in Chief Executive Officer (CEO) bonus plans and CEO power, moderated by compensation committee monitoring. Furthermore, we investigate whether the inclusion of nonfinancial performance measures is associated with higher CEO bonus pay sensitivity to shareholder returns.Research Findings/InsightsUsing a sample of FTSE 350 firms during the period 2007–2013, we find that CEO power is significantly negatively related to the propensity of using nonfinancial performance measures. This negative relationship, however, is moderated by higher levels of compensation committee monitoring. We also find that firms combining nonfinancial and financial performance measures in CEO bonus plans tend to have stronger CEO bonus pay sensitivity to shareholder returns than firms using financial measures alone. Thus, our results suggest that boards of directors adopting nonfinancial performance measures are able to better align CEO incentives with shareholder interests. We find similar results when using the weight of nonfinancial performance measures in the bonus plan in our analyses.Theoretical/Academic ImplicationsThis study empirically supports the managerial power theory whereby powerful CEOs influence the choice of performance measures in their bonus plans. However, effective compensation committees are found to attenuate the influence of powerful CEOs and to better align their interests with those of shareholders. Our result of stronger bonus pay sensitivity to shareholder returns for firms combining nonfinancial with financial performance measures implies that the informativeness of these measures enhances the firm's ability to tie CEO bonus compensation to shareholder wealth.Practitioner/Policy ImplicationsThis study offers insights to members of boards of directors, especially compensation committee members, who are interested in improving the design of executive incentive contracts to better align managerial incentives to shareholder interests. Furthermore, the findings inform regulators about the importance of alternative performance measures in pay‐performance sensitivity and may warrant increased firm disclosure of the details of the pay structure.

This study examines whether the use of non-financial performance measures (NFPMs) in chief executive officer (CEO) compensation contracts is related to stock price crash risk. The literature on NFPMs suggests that incorporating NFPMs into executive compensation contracts motivates managers to engage less in short-term oriented behaviors such as earnings management, while the literature on crash risk focuses on short-term oriented behaviors, such as bad news hoarding, as the main cause for stock price crashes. Based largely on these literatures, we predict that the use of NFPMs in CEO compensation contracts reduces managers’ tendency to hide bad news primarily by over-estimating accruals, thereby leading to a decline in future crash risk. Consistent with this prediction, we find a negative association between the use of NFPMs and subsequent crash risk. Overall, this study enhances our understanding of stock price implications of incorporating NFPMs into CEO compensation contracts.