The Treatment of Special Items In Determining CEO Cash Compensation

• In Event: Executive Compensation

Abstract

This paper reexamines the use of the components of accounting earnings in determining CEO cash compensation using relatively recent and detailed data representative of the evolving nature of nonrecurring items. Scholarship revisiting this relationship is critical, given major changes over time in the regulation and incidence of special items. In a significant improvement over past methodology, I use hand-collected data from compensation committee reports to directly identify firm-year inclusion or exclusion of nonrecurring items in determining bonus performance measures. My results indicate that firms are more likely to exclude the effect of special items in determining CEO cash compensation when the special items are less persistent or effected by regulatory changes, the firms are close to bankruptcy, and when a significant macroeconomic downturn exists. Time series variation in these factors helps explain the inconsistency between prior, larger-sample findings and the current results. Past work shows CEOs are rewarded for any positive component of income and partially shielded from negative special items, but my research indicates that CEOs’ cash compensation is less shielded from negative special items and benefits significantly less from positive special items. It also shows that this shift is significantly related to changes in the nature of special items due to new regulations regarding restructuring and goodwill impairment charges.

Author

• James Potepa, George Washington University