海战博物馆*Corresponding author.Tel.:202/9945089;fax:202/9945164;e-mail:baber @
gwu.edu.Journal of Accounting and Economics 25(1998)169—193
Accounting earnings and executive compensation:
The role of earnings persistence
William R.Baber *,Sok-Hyon Kang ,Krishna R.Kumar
School of Business and Public Management,The George Washington Uni v ersity,NW,Washington,
DC 20052,USA
School of Management,Yale Uni v ersity,New Ha v en,CT 06520,USA
Received 1June 1997;received in revid form 1July 1998
Abstract
A cross-ctional analysis of cash compensation paid to CEOs of 713US firms reveals that the nsitivity of compensation to earnings varies directly with earnings persistence.Additional analysis indicates that this nsitivity is greater for cas where executives are approaching retirement.Such evidence suggests the u of earnings persistence to counterbalance adver conquences of earnings-bad contracting with managers who face finite decision horizons. 1998Elvier Science B.V.All rights rerved.
JEL classi fication:J33;L2;M4
Keywords:Earnings persistence;Executive compensation;Horizon problem
1.Introduction
Contemporary economic theory,which portrays the firm as a ries of contractual relations among stakeholders,establishes a significant role for accounting performance measures when such measures are incrementally in-formative with respect to management’s actions or when their u encourages efficient risk-sharing between contracting parties (Gjesdal,1981;Holmstrom,1979;Lambert and Larcker,1987;Banker and Datar,1989;Sloan,1993).0165-4101/98/$—e front matter 1998Elvier Science B.V.All rights rerved.
PII:S 0165-4101(98)00021-4
170W.R.Baber et al./Journal of Accounting and Economics25(1998)169–193
This role for accounting is supported by evidence of strong contempor-aneous correlations between accounting earnings and executive compensation (e.g.,Lambert and Larcker,1987;Jenn and Murphy,1990;Baber et al., 1996).
Despite this considerable theoretical and empirical justification,performance evaluations bad on ac手工串珠
counting earnings continue to be criticized for encourag-ing actions that sacrifice long-term profitability for short-term profit gains (Smith and Watts,1982;Dechow and Sloan,1991;Kaplan and Atkinson,1998). This drawback,designated the‘horizon problem’,occurs when the decision-maker’s anticipated tenure with thefirm is shorter than thefirm’s optimal investment horizon(Smith and Watts,1982;Johnson,1987;Dechow and Sloan, 1991;Ittner et al.,1997).Prior studies advocate reliance on long-term perfor-mance measures,deferred or stock-bad compensation,or intra-firm monitor-ing to extend management’s decision horizon(Lewellen et al.,1987;Tehranian et al.,1987;Dechow and Sloan,1991).Such mechanisms can temper the horizon problem,yet current earnings cannot easily be dismisd as a less preferred basis for contracting.In particular,both theory and empirical evidence support the premi that earnings are incrementally uful over stock returns and other measures for contracting purpos(Holmstrom,1979;Lambert and Larcker, 1987;Jenn and Murphy,1990;Sloan,1993;Baber et al.,1996).Thus,de-emphasizing current earnings can compromi efficient contracting.
Recent studies suggest that compensation committees adjust earnings-bad performance measures when doing so improves incentive arrangements(Clinch and Magliolo,1993;Dechow et al.,1994;Gaver and Gaver,1998).In this study, we prent evidence that compensation committees c
onsider not only the current-period earnings innovations but also their persistence into the future when rewarding managers bad on earnings. Using a cross-ction of1992 and1993compensation paid to CEOs of713US corporations,wefind that the strength of pay-for-performance relations between CEO salary and bonus and accounting performance increas with measures of earnings persistence.The notion that more persistent earnings innovations are assigned greater value in curities markets is now well documented(Kormendi and Lipe,1987;Collins and Kothari,1989;Ali and Zarowin,1992a);however,whether and why com-pensation committees adjust for earnings persistence in executive compensation contracts are heretofore uninvestigated.
Thefinding that greater weight is assigned to persistent earnings innovations appears to be consistent with compensation committees’efforts to mitigate the Other studies that examine whether compensation committees make informed adjustments on reported earnings include Abdel-Khalik(1985),Healy et al.(1987),Holthaun et al.(1995)and Natarajan(1996).
W.R.Baber et al./Journal of Accounting and Economics25(1998)169–193171 horizon problem.Recall that the horizon problem derives from managers’preferences for lower-NPV projects yielding higher current-period accounting earnings over higher-NPV projects yielding lower current earnings. Arrangements that reward earnings persistence encourage managers to look beyond the current-per
iod earnings and thus extend managers’decision hor-izons,without sacrificing the u of earnings as a contracting vehicle.Additional analysis indicates that relative weights assigned to persistence are greater for CEOs who are approaching retirement.Such individuals face relatively short decision horizons,and therefore,this evidence supports an interpretation that persistent earnings innovations are assigned greater weight to attenuate the horizon problem.
The executive compensation literature also suggests different roles for current cash salary and bonus compensation components than for deferred,typically equity-bad,components(Bizjak et al.,1993;Yermack,1995).Thus,although our primary focus is to ascertain the extent that earnings persistence is related to executive compensation,an ancillary issue is whether persistence manifests differentially for alternative compensation vehicles.Deferred performance-bad components,such as stock options and restricted stock which address long-term conquences of managers’actions,are bad primarily on curity returns. Equity values impound the conquences of earnings persistence,and therefore, conditioning equity-bad components on earnings persistence can be redund-ant.Our evidence is consistent with this reasoning.In particular,wefind positive associations between earnings persistence and weights assigned to current-period earnings innovations for cash salary and bonus components,but not for deferred equity-bad compensation components such as stock options or restricted stock.
Finally,prior studies report statistically significant correlations between the properties of earnings time ries andfirm-specific characteristics,includingfirm size,risk,competition,product types,and earnings respon coefficients(Lev, 1983;Collins and Kothari,1989;Easton and Zmijewski,1989).Other studies indicate that weights assigned to accounting earnings in determining the size and the change of executive compensation also depend onfirm-specific factors such as investment opportunities and the cashflows-versus-accruals composi-tion of reported earnings(Gaver and Gaver,1993;Baber et al.,1996;Natarajan, 1996).Thus,we investigate whether the primary results can be attributed to thefirm-specific characteristics that can be correlated with measures of earn-ings persistence.Wefind that the primary results are robust after considering the characteristics.
The next ction outlines the arguments that guide our expectations about the role of earnings persistence.The data are described in Section3.The primary empirical tests are prented and discusd in Section4.Additional analys that support the primary results are reported and discusd in Section5. Section6summarizes the implications of the study.白茫茫
Results using (1! )to measure earnings persistence are reported as primary results.We also report results for alternative measures of earnings persistence that are suggested in the extant literature.
2.Unexpected accounting earnings and executive compensation
2.1.Earnings inno v ations and earnings persistence
We adopt an IMA (1,1)time-ries characterization of earnings,which facili-tates parsimonious empirical specifications of both earnings innovations and earnings persistence (Beaver,1970;Beaver et al.,1980;Ali and Zarowin,1992b).In particular,
黄疸高是什么原因引起的X R !X R \ "ºE (X R )! ºE (X R \
),(1)where period t earnings innovation ºE (X R )is i.i.d.,and is assumed to be firm-specific.If "0,then earnings follow a random walk process,and all earnings innovations are expected to be permanent (persistent).In contrast,when "1,earnings follow a mean reverting process,and all earnings innova-tions are expected to be transitory .Thus,the parameter (1! ),which measures the extent that earnings innovations are permanent versus transitory,quantifies the notion of earnings persistence.
2.2.The compensation function
Existing studies indicate contemporaneous correlations between stock re-turns and executive compensation (Murphy,1985;Coughlan and Schmidt,1985;Jenn and Murphy,1990),and between a
ccounting earnings and executive compensation (Lambert and Larcker,1987;Dechow et al.,1994).Ron (1992)and Holmstrom (1992),in particular,note the need for considering both ac-counting and curity performance indicators when analyzing executive com-pensation arrangements.Thus,meaningful specifications of relations between compensation and firm performance include both accounting earnings and common stock returns as explanatory variables.Following Lambert and Larcker (1987),Jenn and Murphy (1990),and Baber et al.,(1996),we consider a CEO compensation function
COMP G R " # ºE (R G R )# ºE (X G R )#e G R
,(2)where for firm i and period t , COMP G R is the change in executive compensa-tion,ºE (R G R )is the unexpected common stock return,and ºE (X G R )is the earnings innovation.The intuition behind expression (2)is that changes in compensation respond to unexpected performance in accounting earnings and curity returns —in particular,we expect '0and山药的功效与作用禁忌
'0.172W.R.Baber et al./Journal of Accounting and Economics 25(1998)169–193
Formal analysis indicates that,if earnings persistence is rewarded,then the nsitivity of compensation to earnings innovations can vary with the discount rate (r ).We demonstrate later that
empirical results are robust to a consideration of the discount rate.The principal focus is on the parameter ,which indicates the nsitivity of compensation to earnings innovations.In particular,we are interested in how varies with earnings persistence.For the IMA (1,1)characterization of earn-ings time ries,it can be shown that the expected prent value of earnings innovations is [1#(1! G )/r ]ºE (X G R ),where G is the IMA parameter for firm i and r is the equity discount rate. The unity in the brackets reflects the value of current -period earnings innovations,while the quantity (1! G )/r indicates the prent value of ‘persistent’effects of the earnings innovation.Note that
[1#(1! G )/r ]increas in persistence.If earnings equal cashflows,if earnings time ries follow the IMA(1,1)process,and if compensation committees assign equal weights on current earnings innovations and discounted values of ex-pected earnings in each future period (dollar-for-dollar),then the coefficient on ºE (X G R )equals [1#(1! G )/r ]times a certain (positive)proportionality con-stant —that is, " [1#(1! G )/r ], '0.All three conditions may not hold in practice,but in general,we expect to be increasing in persistence (1! G ).More formally,we specify " # (1! G ),where '0.Thus (expres-sion)(2)becomes
COMP R " # ºE (R R )#[ # (1! )]ºE (X R )#e R
关于桥的对联
,(3)
where firm subscripts i are suppresd to ea the exposition.儿童生长痛
形容快The following hypothesis,stated in the alternative form,applies.H :The nsitivity of CEO compensation to unexpected earnings increas with the extent that earnings innovations are persistent (
'0).A related issue is how associations between compensation changes and accounting earnings depend on whether compensation takes the form of cash or stock.Note that curity prices incorporate both the short-run and the long-run conquences of managers’actions.Thus,conditioning curity returns on earnings persistence can be redundant.To the extent that equity-bad compensation,such as stock options and restricted stock,is determined by curity returns,we expect accounting earnings —and earnings persistence,in particular —to play a more dominant role in the determination of cash,than stock-bad,compensation components.
Two streams of the literature support this characterization.First,a number of studies indicate that the permanent versus transitory distinction is im-pounded in curity prices (Kormendi and Lipe,1987;Collins and Kothari,W.R.Baber et al./Journal of Accounting and Economics 25(1998)169–193173
