Mandatory deferred compensation and the stewardship perspective of financial accounting

• In Event: Financial Accounting and Reporting 7

Abstract

In light of the recent financial crisis and corresponding debates on the pay and incentives of managers, especially in the financial sector, regulators aim at strengthening the sustainability of managerial activities by prescribing deferred compensation for executive contracts. While such deferred compensation can take on multiple forms, we focus on one specific variant which relates post-retirement pay to an accounting performance measure. In a dynamic agency model we analyze analytically how a mandatory deferred compensation regime interacts with characteristics of an accounting system. Employing a three-period model of a principal-agent (owner-manager) relationship, we study optimal linear short-term contracts. Our results reveal that mandatory deferred compensation is no panacea for solving incentive problems as it does not increase shareholder value in every scenario. Deferred compensation is helpful in promoting long-term incentives and potentially mitigates negative effects arising from earnings management. However, its interaction with the timeliness of the accounting system needs to be considered by the regulator in establishing beneficial forms of mandatory deferred compensation. Furthermore, we show that deferred compensation is even more beneficial in renegotiated long-term contractual relationships and might lead the principal to prefer longer managerial tenure.

Authors

• Christoph Pelger, Department of Financial Accounting and Auditing, University of Cologne

• Ulrich Schaefer, Georg-August University at Goettingen