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Is conservatism demanded by performance measurement in compensation contracts? Evidence from earnings measures used in bonus formulas

Author

Listed:
  • Ke Na

    (Cheung Kong Graduate School of Business)

  • Ivy Xiying Zhang

    (University of California, Riverside)

  • Yong Zhang

    (Hong Kong Polytechnic University)

Abstract

We explore the informational properties of earnings that compensation contracting requires for performance measurement. While conditional conservatism could be desirable because it can help to alleviate agency conflicts, its downside relates to the trade-off between conservatism and other important properties, such as persistence. We infer boards’ performance measurement preferences from a novel dataset of earnings realizations used to calculate executive bonus payouts (which we label compensation earnings), which can be either GAAP or non-GAAP. On average, compensation earnings do not exhibit any conditional conservatism in the full sample. The lack of conservatism holds even in subsamples with strong corporate governance and subsamples with high ex ante agency costs, suggesting optimal contract design rather than opportunism. Finally, our analyses indicate that compensation earnings are more persistent and informative than GAAP earnings. Overall our results suggest that boards trade off conservatism for other properties in measuring performance for executive compensation.

Suggested Citation

  • Ke Na & Ivy Xiying Zhang & Yong Zhang, 2024. "Is conservatism demanded by performance measurement in compensation contracts? Evidence from earnings measures used in bonus formulas," Review of Accounting Studies, Springer, vol. 29(1), pages 809-851, March.
    • Handle: RePEc:spr:reaccs:v:29:y:2024:i:1:d:10.1007_s11142-022-09729-6
    DOI: 10.1007/s11142-022-09729-6
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    More about this item

    Keywords

    Conditional conservatism; Performance measurement; Compensation contracting;
    All these keywords.

    JEL classification:

    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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