Accounting earnings and top executive compensation

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Abstract

This paper investigates the role of accounting earnings in top executive compensation contracts. It provides evidence in support of the hypothesis that earnings-based incentives help shield executives from market-wide factors in stock prices. The paper demonstrates that earnings reflect firm-specific changes in value, but are less sensitive to market-wide movements in equity values. As a result, the inclusion of earnings-based performance measures in executive compensation contracts helps shield executives from fluctuations in firm value that are beyond their control. The hypothesis is shown to explain cross-sectional variation in the use of earnings-based incentives.

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    This paper is based on my dissertation at the University of Rochester. I am indebted to my dissertation committee, S.P. Kothari, Kevin Murphy, Jerry Zimmerman, and especially Ross Watts (Chairman), for their guidance and encouragement. I am also grateful for the comments of seminar participants at the University of California, Berkeley, the University of Chicago, Columbia University, Harvard University, the University of Iowa, MIT, the University of Michigan, Northwestern University, the University of Pennsylvania, the University of Rochester, and the University of Washington. Special thanks go to Ray Ball, Patricia Dechow, Rick Lambert, and Dan Collins (the referee) for their many useful comments. I would also like to acknowledge the support of Kevin Murphy in providing me with access to his CEO compensation data. Financial assistance was generously provided by the Deloitte and Touche Foundation. I alone am responsible for the contents.

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