Management Accounting Section Midyear Meeting

CEO Performance Evaluation and Discretionary Bonuses

• In Event: Incentives and Compensation V

Abstract

As objective measures of performance often do not fully reflect CEO effort, compensation committees have the option to use private and qualitative information to subjectively evaluate CEO performance and pay discretionary bonuses. As the accuracy and informativeness of objective performance measures decrease, compensation committees will place decreased weight on performance evaluation based on objective measures and increased weight on subjective evaluation of CEO performance. Using Big 4 auditors and earnings’ ability to predict future cash flows to proxy for the accounting quality, I predict and find that low accounting quality reduces a firm’s tendency to pay formula based bonuses, and increases a firm’s tendency to pay discretionary bonuses. I further find that long-tenured compensation committee members, who usually have more private information, are more likely to subjectively evaluate CEO performance and their evaluation is more accurate as evidenced by a more positive correlation between changes in current discretionary bonuses and changes in future firm performance. Contrary to common beliefs, I find that powerful CEOs are less likely to receive discretionary bonuses.

Author

• Tao Sun, CUNY-Queens College