The use of non-financial performance measures in CEO compensation contracts and stock price crash risk

Abstract

ABSTRACT 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.