Compensation Committees' Treatment of Earnings Components in CEOs' Terminal Years

Compensation committees face special difficulties when setting pay in the last years of a CEO's tenure. For example, incentives to manipulate earnings for the purpose of enhancing earnings-based compensation are greater in CEOs' terminal years.We predict that compensation committees are aw...

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Bibliographic Details
Published in:The Accounting review 2012-01, Vol.87 (1), p.231-259
Main Authors: Huson, Mark R., Tian, Yao, Wiedman, Christine I., Wier, Heather A.
Format: Article
Language:English
Subjects:
Accounting
Benefit plans
Cash
Chief executive officers
Compensation
Creative accounting
Discretionary income
Earnings
Earnings management
Financial management
Future value
Investment strategies
Multivariate analysis
Outliers
Personnel management
Spending
Stock prices
Studies
Time
U.S.A
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Summary:Compensation committees face special difficulties when setting pay in the last years of a CEO's tenure. For example, incentives to manipulate earnings for the purpose of enhancing earnings-based compensation are greater in CEOs' terminal years.We predict that compensation committees are aware of these incentives and adjust the relative weights placed on earnings components in the cash compensation function to mitigate the problem. Consistent with our prediction, we find that in CEOs' terminal years, positive changes in discretionary accruals receive significantly less weight than other income components in determining cash compensation. This provides new evidence that not all gains flow through to compensation. We also find that in non-terminal years, managers' compensation is partially shielded from the negative effects of selling, general, and administrative expenditures (SG&A), but this effect reverses in the terminal period, consistent with the compensation committee discouraging investment in legacy assets by outgoing CEOs. Overall, our findings suggest that compensation committees treat components of earnings differently when setting pay in the terminal period.
ISSN:0001-4826
1558-7967
DOI:10.2308/accr-10164