We examine, both theoretically and empirically, top-management compensation in the presence of agency conflicts when shareholders have delegated governance responsibilities to a self-interested Board of Directors (BOD). We develop a theoretical framework that explicitly incorporates the BOD as a strategic player, models the negotiation process between the CEO and the BOD in designing CEO compensation, and considers the impact of potential takeovers by large shareholders monitoring the CEO-BOD negotiations. In equilibrium, internal governance by the BOD and external takeover threats by a large shareholder act as substitutes in imposing managerial control, especially in constraining management's profligacy in awarding equity-based compensation to itself. The model emphasizes factors in the design of compensation contracts that are rarely considered in the literature, such as equity ownership of the largest outside shareholder and the firm's bankruptcy risk. It also provides new perspectives on factors that are often considered in the literature, such as firm size, firm performance, equity ownership of the BOD, and BOD structure. Our empirical tests lend considerable support for our theoretical predictions. Equity ownership of the largest external shareholder, that of the BOD, and the default risk, are strongly negatively related to the size of CEO equity compensation. Consistent with the theoretical model, these factors do not significantly influence the growth of fixed (or non-performance-related) compensation. We also find that the equity ownership of the BOD is more important in managerial compensation control than other BOD related variables, such as BOD size or the proportion of outside directors.Corporate Governance and Board of Directors, Takeover Threats, Stock Options and CEO Compensation, Default Risk

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This study presents conceptual and empirical analyses of discretionary accrual reversal in the earnings management context. We specifically focus on the extent that income-increasing (decreasing) discretionary accruals initiated in a prior period reverse to become income-decreasing (increasing) accruals in the current period. The analysis suggests that the extent that such reversals constrain the ability to manage toward earnings objectives depends on both the magnitude of past accrual-based earnings management and the reversal speed of past discretionary accruals. To demonstrate the empirical implications of the analysis, we consider discretionary accrual reversal speed as an additional determinant of the balance sheet constraint on earnings management (Barton and Simko 2002). We show that, conditional on the magnitude of net operating asset overstatement, the probability of achieving quarterly earnings forecasts varies inversely with reversal speed.

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.. Wiley and Accounting Research Center, Booth School of Business, University of Chicago are collaborating with JSTOR to digitize, preserve and extend access to Journal of Accounting Research. Existing empirical evidence indicates that analyst forecasts of corporate earnings do not meet the strict rationality standards prescribed by econometric tests of the rational expectations hypothesis.1 In this paper, we address the question of whether the expectation formation process underlying analyst forecasts is adaptive, or whether these forecasts are influenced by noninformational factors, such as incentives arising from the market for their forecasts (O'Brien [1988], Lin and McNichols [1993], Francis and Philbrick [1993], and Dugar and Nathan [1992]), and interaction between judgmental and/or statistical forecasting methods (Bunn and Wright [1991], Fan [1990], and Hoerl and Kennard [1970]).The rejection of rational expectations gives rise to two views of the forecasting process of analysts. The first, based on an informational argument, is that the forecasting process is adaptive (Marcet and Sargent *Carnegie Mellon University. We thank Andrew Alford, Larry Brown, Ravi Bhushan, Rick Green, Paul Healy, Shyam Sunder, and workshop participants at Carnegie Mellon University, M.I.T., SUNY at Buffalo, and the 1992 annual American Accounting Association meetings in Washington, D.C. The last author gratefully acknowledges the KPMG Peat Marwick Research Fellowship. 1 In particular, (i) analysts on average overestimate earnings (Fried and Givoly [1985], O'Brien [1988], and Abarbanell [1991]), and (ii) analyst forecasts appear to be inefficient relative to the information sets used to generate the forecasts (Klein [1990], Abarbanell [1991], and Lys and Sohn [1990]). However, Givoly [1985] reports that analyst forecasts exhibit properties implied by rationality. 103