Management Accounting Section Midyear Meeting

Cost Shielding in Executive Bonus Plans

• In Event: Incentives and Compensation I

Abstract

Boards of directors incorporate a wide variety of performance measures into executive bonus plans. The vast majority of this variation reflects heterogeneity in the choice of specific income statement-based measures (e.g., EBITDA vs. net income)—and thus the extent to which boards disregard certain costs when evaluating executives—but the reasons for these differences are not well understood. We develop a new measure of cost shielding in executive bonus plans and examine whether boards use cost shielding to alleviate agency conflicts between executives and shareholders. Consistent with theoretical predictions, we find that boards select performance measures to shield executives from costs that are (i) noisier signals of executives’ actions; (ii) recognized prior to their associated benefits; or (iii) a result of previous executives’ actions. Our results suggest that a substantial portion of the heterogeneity in executive bonus plan performance measures reflects boards’ efforts to mitigate agency conflicts through cost shielding.

Authors

• Matthew Bloomfield, Wharton School University of Pennsylvania

• Brandon Gipper, Stanford University

• John Kepler, Stanford University

• David Tsui, University of Southern California