Accounting earnings and chief executive officer compensation: the joint effect of earnings' contracting and valuation roles

摘要

This paper investigates the impact of accounting earnings on Chief ExecutiveOfficer (CEO) compensation by examining how the valuation role and the contractingrole of accounting earnings jointly determine the value of CEO total compensation.Current earnings are informative about the firms future cash flows and hence affectstock price, and the resulting price movement affects the value of CEO equity-basedcompensation. Thus, accounting earnings not only have a direct impact on CEO cashcompensation, but also an indirect impact on CEO equity-based compensation due toearnings valuation role. To my knowledge, this paper is the first to provide empiricalevidence that because of earnings valuation role, accounting earnings are aneconomically significant determinant of CEO total compensation.Prior accounting research testing predictions of agent theory has focused on CEOcash compensation even though total compensation is a more relevant measure. Thus,the significant result of earnings in CEO total compensation enables re-examination ofagency predictions. I provide evidence that earnings (but not stock returns) are used inCEO total compensation consistent with the sensitivity vs. precision hypothesis. That is, accounting earnings receive less weight when earnings are relatively more volatileand when firms have significant growth opportunities.