CEO Bonus Compensation Research Articles

Effect of Directors' Bonus Compensation, Institutional Ownership and Size of The Board of Directors on Profit Management

The current business development is very fast, which encourages organizations to be able to continue to present reliable and accountable financial information for their users. Reliable financial information is very necessary for decision-makers, especially stakeholders and potential investors, especially to make investments. Unqualified and reliable financial statements produce Earning Management and Financial Fraud Reporting. Research design is a blueprint, that is, a design for collecting, measuring, and analyzing data, which is designed to answer the formulation of problems. This study used a descriptive research design. This research is research with a quantitative approach. The purpose of this study is to analyze the influence between exogenous variables to endogenous variables, so this study is a type of Causal research. The type of quantitative research in this study is causal studies, which is a type of research based on the concept of cause. The conclusion of the results of this study is that CEO bonus compensation and the size of the board of directors have a positive effect on earnings management.

Determints of CEO Bonus Compensation

Abstract The primary purpose of this study is to explore the determinants of CEO bonus compensation: to examine CEO bonuses and to explore whether or not the independent variables are associated with CEO bonus compensation. For the purposes of this study, a sample of 2,448 CEO bonus compensations across 1,622 firms from 1997 to 2002 was used to test several hypotheses. The dependent variable in this model is the CEO bonus compensation. Bonus is the dollar value of the bonus (cash and non-cash) earned by the named executive officer during the fiscal year. Corporate diversification was divided into two categories; international diversification and industry diversification. Firm performance is measured by both Market-based, Performance (RET) and Accounting-based, Performance (ACE). The results show that the higher the degree of international diversification, and the higher accounting earnings performance, the more CEOs receive in bonuses. In addition, this study found that international diversification is associated with a greater use of bonuses and with a greater reliance on accounting-based, rather than market-based measures of firm performance. The results also demonstrated that CEOs in firms with more investment opportunities will receive higher bonuses than CEOs in firms with fewer investment opportunities and CEOs in larger firms will receive higher bonuses than CEOs in smaller firms.

Corporate Governance, CEO Compensation and Accounting Conservatism

Purpose:This study examines the moderating impact of corporate governance quality on the relation between CEO bonus compensation and accounting conservatism.

CEO Bonuses as Studied by Robust Logistic Regression

This investigation utilized a robust logistic regression method (BYLOGREG) to investigate CEO bonuses prior to the 2007-2009 financial crisis. The robust logistic regression analysis determined that the year and CEO tenure affected the probability that a CEO received a bonus in the 2004-2006 study period. The analysis refuted that ”management entrenchment” widely influenced CEO bonus compensation because the probability of receiving a bonus was negatively related to CEO tenure. The probability of receiving of bonus declined during the 2004-2006 study period because the percentage of CEOs that received a bonus was lowest in 2006. The robust logistic regression analysis found that the current year stock return was positively and statistically significantly related to the probability that a CEO received a bonus. The analysis also showed that managerial (financial) performance in the areas of growth of sales, ROE, and growth in earnings per share increased the probability that a CEO received a bonus. In this investigation, the size of the firm and the growth rate of equity were not statistically significant. Overall, robust logistic regression correctly classified 77% of the observations on the basis of the model variables, which indicated that most CEO bonuses could be explained by firm, CEO, and financial variables.The BY robust logistic regression proved to be robust to outliers in the CEO bonus sample studied. Interestingly, the relationship between stock return and the probability of a bonus was completely missed by a maximum likelihood (ML) logistic regression with the full CEO bonus sample, which contained outliers. After trimming the CEO bonus data set to remove outliers, the ML logistic regression coefficients changed dramatically. However, the BY robust logistic regression coefficients changed very little. Use of the residuals from the BY robust logistic equation should facilitate further inquiry into CEOs that received a bonus but were predicted to have a low probability of a bonus.

The impact of corporate governance on the relationship between earnings management and CEO compensation

PurposeThe study examines whether corporate governance moderates the relationship between CEO compensation and earnings management.Design/methodology/approachThe study uses 1,800 firm-year observations from 2005 to 2010 and employ multiple regression analyses and other sensitivity tests.FindingsThe study finds a positive relationship between CEO compensation and earnings management. The study’s results also suggest that CEO bonus compensation increases in relation to earnings management and therefore the study infers that managers may become involved in earnings management to increase their compensation. However, the study finds that the relationship is moderated by a strong corporate governance system which reduces the impact of earnings management on CEO compensation.Research limitations/implicationsThe study is conducted in a specific context, and therefore it may be subject to a set of limitations. The study emphasises exclusively on whether executives manage earnings to increase their compensation. The study does not consider the issue of several other and potentially contradictory motivations here.Practical implicationsThe study’s findings highlight potential implications and offer useful propositions for stakeholders, particularly accounting and corporate governance regulators, to consider. The findings offer a basis for the accounting professions to further discuss and improve accounting standards to provide adequate regulations and monitoring to decrease managerial opportunistic behaviours in earnings manipulations. The findings also emphasise the need for appropriately designed CEO compensation packages in such a manner that improves the manager–shareholder alignment and reduces the information asymmetry problem. The results signify that corporate governance plays a vital role in mitigating the relationship between CEO compensation and earnings management.Originality/valueThis study adds to the existing literature by documenting empirical support on the link between earnings management and CEO compensation against a backdrop of high demand for strong corporate governance practices.

Getting compensation right - The choice of performance measures in CEO bonus contracts and earnings management

This paper examines whether the choice of performance measures in CEO bonus compensation contracts is associated with earnings management. From a sample of FTSE350 Index firms over the period of 2005–2014, we investigate the relationship between earnings management, through discretionary accruals and real activities management, and (1) the use of and extent of reliance on financial and non-financial performance measures in CEO bonus contracts; and (2) the use of long-term and short-term measures in CEO bonus contracts. We find less income-increasing manipulation through discretionary accruals and expenses when non-financial performance measures (NFPMs) are used alongside financial performance measures (FPMs) and when the NFPMs are used to a larger extent than FPMs. Furthermore, we find less discretionary accruals when long-term performance measures are used. This implies that non-financial and long-term measures encourage executives to work towards the long-term success of the company rather than their own short-term reward.

The executive compensation implications of the tax component of earnings

We extend prior research by examining the weight applied to earnings generated by changes in ETRs (i.e., the tax component of earnings) in determining CEO and CFO compensation. We examine both bonus and total compensation and find that the predicted relationships between compensation and the tax component of earnings are largely limited to bonus compensation. This is not surprising since bonus compensation represents an unambiguous link between contemporaneous performance and compensation, while equity compensation is in part determined by agency considerations. Our evidence suggests that both CEOs and CFOs are compensated for the tax component of earnings. We find that CEOs are rewarded equally for the tax component of earnings relative to other components of earnings, while CFOs are rewarded more for the tax component of earnings relative to other components of earnings. Additionally, the weight applied to the tax component of earnings when determining CFO bonus compensation is greater when; (1) the tax component of earnings does not appear to be related to earnings management; (2) ETRs decrease rather than increase, (3) the firm pays bonus based on after-tax earnings rather than pre-tax earnings, and (4) the firm is tax aggressive rather than non-tax aggressive. The variations in the weighting of the tax component of earnings for CFO bonus compensation noted above in combination with evidence that CEO bonus compensation is indifferent to ETR-related earnings versus other components of earnings, suggests that the tax component of earnings is a contractual component of CFO bonus compensation.

Cost behavior and executive bonus compensation

Prior literature provides compelling evidence of an asymmetric relation between executive bonus compensation and earnings performance. In particular, this literature reports that compensation committees assign greater weight to good (positive) earnings performance than poor (negative) earnings performance. Taken together, the prior literature provides strong support for critics who claim that compensation committees blindly protect executives from earnings underperformance. We further examine this issue by investigating whether a firm's cost behavior (i.e., the relation between expenses and sales) provides an explanation for the apparent inefficiency in executive compensation contracts. Our evidence suggests that executives are rewarded more for increases in ROA that arise from normal cost behavior than other increases in ROA consistent with these increases being perceived as more persistent. In contrast, we do not find such a relationship for decreases in ROA which suggests that executives are largely shielded from decreases in ROA that follow normal cost behavior. We examine two factors suggested by the prior literature, expected future sales and the extent of capacity utilization, which may provide an explanation for why executives are shielded from normal cost behavior decreases in ROA. When these additional factors are included in our empirical models, our evidence suggests that the asymmetric relation between changes in CEO bonus compensation and increases and decreases in earnings performance documented in prior literature goes away. That is, our results suggest that compensation committees do not blindly protect executives for earnings underperformance. On the contrary, our evidence suggests that these committees take into account other non-earnings information when deciding how much weight to give to a decrease in earnings and that executive compensation may not be as inefficient as suggested by prior research.

CEO Bonus Compensation and Bank Default Risk: Evidence from the U.S. and Europe

We investigate the link between the incentive mechanisms embedded in CEO cash bonuses and the riskiness of banks. For a sample of U.S. and European banks, we employ the Merton distance to default model to show that increases in CEO cash bonuses lower the default risk of a bank. However, we find no evidence of cash bonuses exerting a risk‐reducing effect when banks are financially distressed or when banks operate under weak bank regulatory regimes. Our results link bonus compensation in banking to financial stability and caution that attempts to regulate bonus pay need to tailor CEO incentives to the riskiness of banks and to regulatory regimes.

CEO bonus compensation: the effects of missing analysts’ revenue forecasts

We investigate the incremental contract relevance of analysts’ revenue forecasts while controlling for earnings forecasts and find CEOs receive smaller bonuses when missing analysts’ annual and quarterly revenue expectations. Our results support the link between the value relevance of the revenue performance measure and the contract relevance of that measure. Further, we find revenue forecasts to be more contract relevant for CEOs of firms with high growth expectations, consistent with Rees and Sivaramakrishnan’s Contemp Acc Res 24(1):259–290, (2007) findings that growth firms receive a larger market penalty for missing revenue targets. Overall, our findings provide empirical support for the conjecture that compensation committees rely on information consistent with that conveyed in analysts’ revenue forecasts when contracting with management.

CEO Bonus Compensation and Bank Default Risk: Evidence from the U.S. and Europe

We investigate the link between the incentive mechanisms embedded in CEO cash bonuses and the riskiness of banks. For a sample of U.S. and European banks, we employ the Merton distance to default model to show that increases in CEO cash bonuses lower the default risk of a bank. However, we find no evidence of cash bonuses exerting a risk-reducing effect when banks are financially distressed or when banks operate under weak bank regulatory regimes. Our results link bonus compensation in banking to financial stability and caution that attempts to regulate bonus pay need to tailor CEO incentives to the riskiness of banks and to regulatory regimes.

Executive compensation regulation and the dynamics of the pay-performance sensitivity

A substantial number of empirical studies on the linear relationship between executive compensation and firm performance for European firms suggest that the pay-performance sensitivity is not significantly positive. We argue that a nonlinear structure fits the data better, because compensation contracts provide for minimum performance benchmarks and an upper limit to the variable component of compensation. We test for such discontinuities in the pay performance relationship, and confirm their existence, using hand collected data from German Prime All Share firms’ CEO bonus compensation. It turns out that there is a significant positive relationship between return on assets and CEO bonus for ROA between -3% and +20%. Performance sensitivity is then tested for changes over time between 2006 and 2009. Results reveal that during the first three years after the introduction of a statutory transparency rule in 2005 governing the disclosure of individual CEO compensation, significant changes to compensation contracts did not occur; but that in 2009 the pay-performance sensitivity exhibited a significant increase, which coincides with the passing of a law that requires supervisory boards to ensure that new CEO employment contracts provide for ’reasonable’ compensation.

CEO Bonuses, Relative Performance Evaluation, and Pay-for-Luck

This study investigates whether the inconsistent findings on the implementation of relative performance evaluation (RPE) can be explained by CEOs’ control over their pay process and by the interaction of RPE with pay-for-luck. Using a sample of CEO bonus compensation awards from 1992 to 2008, we test whether there is asymmetric use of RPE and pay-for-luck that indicates CEO power over the compensation process. Specifically we identify the conditions under which a CEO would or would not prefer, ex post, the implementation of RPE and pay-for-luck and analyze whether the sensitivity of bonus compensation to industry-adjusted firm performance varies depending on industry performance and firm performance relative to the industry. Our results suggest that CEO bonus compensation is more sensitive to industry-adjusted performance when the firm outperforms its industry benchmark (asymmetric RPE) and when the industry benchmark is positive (asymmetric pay-for-luck), consistent with CEO manipulation of the pay process to extract rents from the firm. We also find that there is a limit to the magnitude of this rent extraction, however, since CEOs are not paid for good luck when they are already being paid for beating the industry benchmark (that is, there is no evidence of double-dipping). In sum, our findings are consistent with a weak implementation of RPE (which may be efficient contracting), where the manager is shielded from extremely bad outcomes but at the same time not excessively rewarded when the combination of firm and industry performance (i.e., talent and luck) is extremely good.

Cost Behavior and Executive Compensation

Prior literature provides compelling evidence of an asymmetric relation between executive bonus compensation and earnings performance. In particular, this literature reports that compensation committees assign greater weight to good (positive) earnings performance than poor (negative) earnings performance. Taken together, the prior literature provides strong support for critics who claim that compensation committees blindly protect executives from earnings underperformance. We further examine this issue by investigating whether a firm’s cost behavior (i.e., the relation between expenses and sales) provides an explanation for the apparent inefficiency in executive compensation contracts. Our evidence suggests that executives are rewarded more for increases in ROA that arise from normal cost behavior than other increases in ROA consistent with these increases being perceived as more persistent. In contrast, we do not find such a relationship for decreases in ROA which suggests that executives are largely shielded from decreases in ROA that follow normal cost behavior. We examine two factors suggested by the prior literature, expected future sales and the extent of capacity utilization, which may provide an explanation for why executives are shielded from normal cost behavior decreases in ROA. When these additional factors are included in our empirical models, our evidence suggests that the asymmetric relation between changes in CEO bonus compensation and increases and decreases in earnings performance documented in prior literature goes away. That is, our results suggest that compensation committees do not blindly protect executives for earnings underperformance. On the contrary, our evidence suggests that these committees take into account other non-earnings information when deciding how much weight to give to a decrease in earnings and that executive compensation may not be as inefficient as suggested by prior research.

Sticky Costs and Executive Compensation

Shareholders have recently criticized compensation committees for blindly protecting executives from earnings underperformance. We investigate this claim by considering whether compensation committees consider the sticky cost relation between sales and expenses in determining executive bonus compensation. Prior research offers two distinct, but related explanations for why costs tend to be sticky: excess capacity and expected future sales activity. Our evidence suggests that compensation committees consider the relation of sales and expenses, expected future sales and the extent of capacity utilization in determining CEO bonuses. When these factors are controlled for, our evidence suggests that the weak link between CEO bonus compensation and earnings underperformance documented in the prior literature goes away. That is, our results suggest that compensation committees do not blindly protect executives for earnings underperformance. On the contrary, our evidence suggests these committees take into account other non-earnings information when deciding how much weight to give to a decrease in earnings.

Is CEO Compensation Shielded from Overproduction?

In this study I examine whether compensation committees in manufacturing firms seek to shield CEO compensation from overproduction. I first hypothesize that CEO compensation contracts are optimal in the sense that overproduction has an incremental negative effect on earnings weight in CEO compensation contract. I measure overproduction by using positive change in percent of production added to inventory (PCPAI). Consistent with my hypothesis, PCPAI has significant incremental explanatory power on earnings weight in both CEO total compensation and CEO bonus compensation. In addition, I hypothesize and find that the incremental effect of PCPAI on earnings weight is significantly more negative in CEO total compensation in presence of just meeting or beating analyst earnings expectation or small profit. The results are also robust to adjusting for annual inflation growth and controlling for CEO-specific fixed effects. Overall, these findings suggest that in manufacturing firms, compensation committees perceive the apparent overproduction and at least partially mitigate the effect of overproduction on CEO compensation, and the mitigating effect is more prominent when overproduction is more likely to be opportunistic.

Relative Bonus Compensation: The Role of Executive Rank and Non-linearity

The sensitivity of the rank of the change in bonus compensation to firm performance is compared between CEOs and non-CEOs. Executives are classified into four groups: 1) CEOs, 2) high ranking executives, 3) business unit managers, and 4) low ranking executives. There are no differences in bonus compensation between the four categories of executives when firm performance is moderate. However, when performance is very bad (good), CEO bonus compensation is significantly smaller (larger). Differences between CEOs and non-CEOs are limited to differences in intercepts related to the sign of performance and not slope coefficients on performance.