The Determinants of Performance Plan Adoption

Abstract

Executive compensation schemes are expected to reduce agency costs by aligning the interests of stockholders and managers. We attempt to determine the characteristics of companies that adopt long-term performance plans. Using a matched-pair design, we conduct a multivariate logit analysis that is weighted to take into account the choice-based nature of the sample. Our results suggest that performance plans may have been adopted to complement the inadequate compensation derived from stock options. In addition, we find that performance plans are more likely to be adopted by companies who have smaller investment opportunity sets and have older managers who are underinvesting in R&D expenditures.

The Effect of Adopting Accounting-Based Bonus and Performance Incentive Plans on the Earnings Response Coefficient

“…An examination of residuals indicates that the model is well specified.24 As predicted by hypothesis 1, results show that for the sample of firms that adopt bonus plans, the ERC is lower in the postadoption 21. Brozovsky and Sopariwala (1995) measure a firm's investment opportunity set as the ratio of market value of equity to book value of common stockholders' equity.…”

“…In general, firms adopt compensation plans to reduce agency costs by aligning the interests of managers and stockholders (Smith and Watts [ 19821;Lambert and Larcker [ 19851;Brozovsky and Sopariwala [1995]). Bonus and performance incentive plans' reward managers when accounting-based performance goals are achieved.…”

“… Brozovsky and Sopariwala (1995). find that performance incentive plans are more likely to be adopted by companies who have smaller investment opportunity sets.…”

Students as surrogates for managers: Evidence from a replicated experiment

“…In an agency theory context, managers are assumed to take the course of action that increases their utility (Jensen & Meckling, 1976;Watts & Zimmerman, 1986). Compensation plans, including bonuses, are meant to align managers' interests with those of shareholders and other stakeholders (Brozovsky & Sopariwala, 1995;Duru, Mansi, & Reeb, 2005;Lambert & Larcker, 1987;Smith & Watts, 1982), but they may also induce a manager to adopt accounting alternatives that increase his/her bonus (e.g., Healy, 1985;Holthausen, Larcker, & Sloan, 1995). While we assumed managers were able to draw on their work experiences (and possibly education) to identify when the case subject is likely to choose an accounting treatment resulting in a higher bonus, the students in this study have less direct experience with the effects of compensation plans.…”

“…In an agency theory context, managers are assumed to take the course of action that increases their utility (Jensen & Meckling, ; Watts & Zimmerman, ). Compensation plans, including bonuses, are meant to align managers’ interests with those of shareholders and other stakeholders (Brozovsky & Sopariwala, ; Duru, Mansi, & Reeb, ; Lambert & Larcker, ; Smith & Watts, ), but they may also induce a manager to adopt accounting alternatives that increase his/her bonus (e.g., Healy, ; Holthausen, Larcker, & Sloan, ).…”