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The use of adjusted earnings in performance evaluation

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  • Asher Curtis

    (University of Washington)

  • Valerie Li

    (San Diego State University)

  • Paige H. Patrick

    (University of Illinois at Chicago)

Abstract

We document widespread adoption of adjustments to earnings for performance evaluation; 84% of our sample of S&P 1500 firms use adjusted earnings for bonus compensation. We find that the transactions removed from adjusted earnings vary widely and include both transitory and nontransitory items. We examine the determinants of using adjusted earnings and find some evidence that boards are more likely to contract using adjusted earnings when firms have high levels of intangible assets, more volatile earnings, CEOs with shorter tenures, CEOs who also act as board chairperson, or larger compensation committees or are reporting losses. We find that firms with an independent chairperson or lead director are less likely to contract using adjusted earnings. We examine the compensation consequences of the use of adjusted earnings and find that CEOs compensated on adjusted earnings are less likely to miss minimum bonus thresholds, are less likely to meet maximum bonus thresholds, and have higher overall bonus compensation, controlling for firm performance. Taken together, our analyses suggest that both managerial power and efficient contracting concerns explain the use of adjusted earnings in CEO compensation contracts.

Suggested Citation

  • Asher Curtis & Valerie Li & Paige H. Patrick, 2021. "The use of adjusted earnings in performance evaluation," Review of Accounting Studies, Springer, vol. 26(4), pages 1290-1322, December.
    • Handle: RePEc:spr:reaccs:v:26:y:2021:i:4:d:10.1007_s11142-021-09580-1
    DOI: 10.1007/s11142-021-09580-1
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    3. Ryan D. Guggenmos & Kristina Rennekamp & Kathy Rupar & Sean Wang, 2022. "The Relationship Between Non‐GAAP Earnings and Aggressive Estimates in Reported GAAP Numbers," Journal of Accounting Research, Wiley Blackwell, vol. 60(5), pages 1915-1945, December.
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    5. Miguel Faria-e-Castro & Radhakrishnan Gopalan & Avantika Pal & Juan M. Sanchez & Vijay Yerramilli, 2022. "EBITDA Add-backs in Debt Contracting: A Step Too Far?," Working Papers 2022-029, Federal Reserve Bank of St. Louis.
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    7. Sascha B. Herr & Peter Lorson & Jochen Pilhofer, 2022. "Alternative Performance Measures: A Structured Literature Review of Research in Academic and Professional Journals," Schmalenbach Journal of Business Research, Springer, vol. 74(3), pages 389-451, September.
    8. Mark Brosnan & Keith Duncan & Tim Hasso & Janice Hollindale, 2023. "Non‐GAAP earnings and executive compensation: An experiment," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(4), pages 4375-4398, December.

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