Management Accounting Section Midyear Meeting

Sales-Based CEO Pay and Its Effect Across the Supply Chain

• In Event: Supply Chain

Abstract

A growing number of firms are using sales measures in their CEO compensation contracts. However, as sales are a narrow measure of performance (Ittner and Larcker 2002) that do not account for activities that increase costs, using sales measures can distort managerial incentives away from firm value maximization. In this study, I expect that sales measures incentivize the CEO to increase inventory reserves to prevent lost sales and accelerate sales realizations. This inefficient inventory management causes an increase in production volatility and exacerbates the bullwhip effect, which refers to the widespread phenomenon where the volatility of production tends to be higher than the volatility of demand (Lee et al. 1997a; Lee et al. 1997b). The bullwhip effect has been documented as a substantial driver of operating costs for the firm and its supplier, which suggests that the use of sales measures can have unintended negative consequences. The results are robust to using network connections to other firms using sales measures as instrumental variables.

Author

• Jen Choi, Emory University