nach oben

Review of Quantitative Finance and Accounting

Erschienen in:

10.03.2016 | Original Research

The executive compensation implications of the tax component of earnings

verfasst von: Victoria Hansen, Thomas J. Lopez, Austin Reitenga

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 3/2017

Einloggen

Aktivieren Sie unsere intelligente Suche, um passende Fachinhalte oder Patente zu finden.

search-config

KI-gestützte Suche

Aus

Abstract

We extend prior research by examining the weight applied to earnings generated by changes in ETRs (i.e., the tax component of earnings) in determining CEO and CFO compensation. We examine both bonus and total compensation and find that the predicted relationships between compensation and the tax component of earnings are largely limited to bonus compensation. This is not surprising since bonus compensation represents an unambiguous link between contemporaneous performance and compensation, while equity compensation is in part determined by agency considerations. Our evidence suggests that both CEOs and CFOs are compensated for the tax component of earnings. We find that CEOs are rewarded equally for the tax component of earnings relative to other components of earnings, while CFOs are rewarded more for the tax component of earnings relative to other components of earnings. Additionally, the weight applied to the tax component of earnings when determining CFO bonus compensation is greater when; (1) the tax component of earnings does not appear to be related to earnings management; (2) ETRs decrease rather than increase, (3) the firm pays bonus based on after-tax earnings rather than pre-tax earnings, and (4) the firm is tax aggressive rather than non-tax aggressive. The variations in the weighting of the tax component of earnings for CFO bonus compensation noted above in combination with evidence that CEO bonus compensation is indifferent to ETR-related earnings versus other components of earnings, suggests that the tax component of earnings is a contractual component of CFO bonus compensation.

Nächster Artikel The joint determinants of cash holdings and debt maturity: the case for financial constraints

Sie haben noch keine Lizenz? Dann Informieren Sie sich jetzt über unsere Produkte:

Springer Professional "Wirtschaft+Technik"

Online-Abonnement

Mit Springer Professional "Wirtschaft+Technik" erhalten Sie Zugriff auf:

über 102.000 Bücher
über 537 Zeitschriften

aus folgenden Fachgebieten:

Automobil + Motoren
Bauwesen + Immobilien
Business IT + Informatik
Elektrotechnik + Elektronik
Energie + Nachhaltigkeit
Finance + Banking
Management + Führung
Marketing + Vertrieb
Maschinenbau + Werkstoffe
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

Jetzt informieren

Springer Professional "Wirtschaft"

Online-Abonnement

Mit Springer Professional "Wirtschaft" erhalten Sie Zugriff auf:

über 67.000 Bücher
über 340 Zeitschriften

aus folgenden Fachgebieten:

Bauwesen + Immobilien
Business IT + Informatik
Finance + Banking
Management + Führung
Marketing + Vertrieb
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

Jetzt informieren

Nur mit Berechtigung zugänglich

Specifically, Hollingsworth (2002) reports that 86 percent of the corporate tax department executives who responded to her 2001 survey cite tax savings as an important metric in their performance evaluation and 56 percent specifically note the use of ETRs as a performance benchmark. More importantly, Hollingsworth reports that 60 percent of these executives state that these measures are used in determining their compensation.

The tax component of earnings is measured as the pretax return on assets times the change in the effective tax rate.

In addition to the change in ETR measure mentioned above, we also estimate two additional changes in ETR measures to calculate TAX_COMP. The first is based on the method of Abarbanell and Bushee (1997). Their measure calculates the change in ETR as the prior three-year average ETR less the current year ETR. The second is a change in cash ETR measure consistent with Dyreng et al. (2008). Specifically, we measure the change in the cash ETR as the prior 5-year cash ETR less the current cash ETR. Our results (not reported) are robust to the calculations of TAX_COMP using the Abarbanell and Bushee (1997) method. We discuss the empirical results using the cash ETR in the sensitivity analysis section.

In additional testing (not reported), we replicate the work of Schmidt (2006) with our sample.

We use two additional procedures to test the influence of earnings management. First, Schmidt (2006) suggests the initial tax component of earnings (i.e., based on the first quarter ETR) is more persistent for future earnings than is the revised tax component of earnings (i.e., based on the end of year ETR). In supplemental testing (not tabulated), we re-estimate Eq. (2) using first quarter ETR as the measure of the expected ETR. Our conclusions are robust to this alternative specification. Second, Dhaliwal et al. (2004) report that firms’ lower their fourth-quarter ETRs when they would otherwise miss their consensus earnings forecast absent tax expense manipulation. Thus, rather than using prior year’s ROA as the benchmark, we re-estimate our tests based on whether the 4th quarter tax component of earnings is greater than the analysts’ earnings forecast error. Our conclusions are robust to this alternative specification. We do not use this as our primary test as we lose over half of our sample observations when we include analysts’ forecasts in our data set.

Gaertner (2014) validates this model by choosing a random sample of fifty firms. The model has an accuracy rate of 94 % in predicting before or after-tax compensation of the executive.

We use the CFOANN and job title fields in ExecuComp to identify CFOs. Any executive not identified in the CFOANN field that has a job title including the terms CFO or “chief financial” is coded as a CFO.

The exceptions are ∆ADJ_ROA*PERS which is insignificant for CEO total compensation, PSI which is insignificant for CFO bonus compensation and CEO total compensation, and NSI which is insignificant for CFO total compensation.

We employ two separate measures of discretionary accruals (PADCA and REDCA) that control for firm performance based on the work of Ashbaugh et al. (2003). The first measure of discretionary accruals, PADCA, controls for firm performance through a portfolio technique. The second measure of discretionary accruals, REDCA, adjusts for firm performance by including lagged return on assets in the regression model used to estimate non-discretionary accruals. The specific procedures for estimating both measures are discussed in Ashbaugh et al. (2003, 621–622).

The only exception is DTAX in the bonus compensation model where we find HTAX_COMP is significantly greater than LTAX_COMP (two-tailed p value <0.10).

If minority interest (#49), current foreign tax expense (#64), income from unconsolidated entities (#55), or current state tax expense (#173) is missing on Compustat, then we set MI, CFOR, UNCON, or CSTE, respectively, to zero. If current federal tax expense (#63) is missing on Compustat, then we set the value of CFTE to: total tax expense (#16) less current foreign tax expense (#64) less current state tax expense (#173) less deferred tax expense (#50). If goodwill and other intangibles (#33) is missing on Compustat, then we set the value for INTANG to 0. If #33 = C, then we set the value of INTANG to that for goodwill (#204).

Abarbanell J, Bushee B (1997) Fundamental analysis, future earnings, and stock prices. J Account Res 35(1):1–24CrossRef

Adut D, Cready W, Lopez T (2003) Restructuring charges and CEO cash compensation: a reexamination. Account Rev 78(1):169–192CrossRef

Aggarwal RK, Samwick A (2003) Performance incentives within firms: the effect of managerial responsibility. J Finance 58:1613–1649CrossRef

Antle R, Demski J (1988) The controllability principle in responsibility accounting. Account Rev 63(4):700–718

Armstrong C, Blouin J, Larcker D (2012) The incentives for tax planning. J Account Econ 53(2):391–411CrossRef

Ashbaugh H, LaFond R, Mayhew B (2003) Do nonaudit services compromise auditor independence? Further evidence. Account Rev 78(3):611–639CrossRef

Atwood TJ, Omer T, Shelley M (1998) Before versus after-tax earnings as performance measures in compensation contracts. Manag Finance 11:30–44

Baber W, Kang S, Kumar K (1998) Accounting earnings and executive compensation: the role of earnings persistence. J Account Econ 25(2):169–193CrossRef

Bauman M, Shaw K (2005) Interim income tax data and earnings prediction. J Am Tax Assoc 27(2):57–82CrossRef

Brown J, Drake K, Martin M (2011) Are firms myopic? The case of contracting on performance and uncertainty. Working paper. Arizona State University

Bryant-Kutcher L, Guenther D, Jones D (2009) Earnings persistence and the value of change in firms’ effective tax rates. Working paper Colorado State University

Bushman R, Indjejikian R, Smith R (1995) Aggregate performance measures in business unit manager compensation: the role of intrafirm interdependencies. J Account Res 33:101–128CrossRef

Cao J, Laksmana I (2010) The effect of capital market pressures on the association between R&D spending and CEO option compensation. Rev Quant Finance Account 34(2):273–300CrossRef

Carnes G, Guffey D (2000) The influence of international status and operating segments on firms’ choice of bonus plans. J Int Account Audit Tax 9(1):43–57CrossRef

Carter ME, Lynch LJ, Zechman SL (2009) Changes in bonus contracts in the post-Sarbanes–Oxley era. Rev Account Stud 14(4):480–506CrossRef

Cheng S (2004) R&D expenditures and CEO compensation. Account Rev 79(April):305–328CrossRef

Cook K, Huston GR, Omer T (2008) Earnings management through effective tax rates: the effects of tax-planning investment and the Sarbanes–Oxley act of 2002. Contemp Account Res 25(2):447–471CrossRef

Core J, Guay W (1999) The use of equity grants to manage optimal equity incentive levels. J Account Econ 28:151–184CrossRef

Core J, Holthausen R, Larcker D (1999) Corporate governance, chief executive officer compensation, and firm performance. J Finance Econ 51(March):371–406CrossRef

Dechow P, Huson M, Sloan R (1994) The effect of restructuring charges on executives’ cash compensation. Account Rev 69(1):138–156

Dechow P, Myers L, Shakespeare C (2010) Fair value accounting and gains from asset securitizations: a convenient earnings management tool with compensation side-benefits. J Account Econ 49(1–2):2–25CrossRef

Desai M, Dharmapala D (2006) Corporate tax avoidance and high-powered incentives. J Finance Econ 88:1–25

Dhaliwal D, Gleason C, Mills L (2004) Last chance earnings management: using the tax expense to achieve earnings targets. Contemp Account Res 21(2):431–458CrossRef

Douglas R, Ellingsworth P, McAndrews J (1996) What management expects: evaluation of the tax department and its executives. Tax Exec 48:29–32

Duru A, Iyengar R, Thevaranjan A (2002) The shielding of CEO compensation from the effects of strategic expenditures. Contemp Account Res 19(2):175–193CrossRef

Dyreng S, Hanlon M, Maydew E (2008) Long-run corporate tax avoidance. Account Rev 83(1):61–82CrossRef

Dyreng S, Hanlon M, Maydew E (2010) The effects of executives on corporate tax avoidance. Account Rev 85(4):1163–1189CrossRef

Frank MM, Lynch LL, Rego SO (2009) Tax reporting aggressiveness and its relation to aggressive financial reporting. Account Rev 84(2):467–496CrossRef

Freeman T (2010) What should a CFO know about tax. Finance Exec 26:52–55

Gaertner F (2014) CEO: after-tax compensation incentives and corporate tax avoidance. Contemp Account Res 31(4):1077–1102CrossRef

Gaver J, Gaver K (1998) The relation between nonrecurring accounting transactions and CEO cash compensation. Account Rev 73:235–254

Gleason D, Mills L (2008) Evidence of differing market responses to beating analysts’ targets through tax expense decreases. Rev Account Stud 13:295–318CrossRef

Gow I, Ormazabal G, Taylor D (2010) Correcting for cross-sectional and time-series dependence in accounting research. Account Rev 85(2):483–512CrossRef

Graham J, Tucker A (2006) Tax shelters and corporate debt policy. J Finance Econ 81(September):563–594CrossRef

Gul F, Chen C, Tsui J (2003) Discretionary accounting accruals, managers’ incentives, and audit fees. Contemp Account Res 20(3):441–464CrossRef

Hanlon M, Heitzman S (2011) A review of tax research. J Account Econ 50:127–178CrossRef

Hanlon M, Mills L, Slemrod J (2005) An empirical examination of corporate tax noncompliance. In: Auerbach A, Hines J, Slemrod J (eds) Taxing corporate income in the twenty-first century. Cambridge University Press, Cambridge

Healy R (1985) The effect if bonus schemes on accounting decisions. J Account Econ 7(1–3):85–107CrossRef

Healy P, Kang S, Palepu K (1987) The effect of accounting procedure changes on CEOs’ cash salary and bonus compensation. J Account Econ 9(April):7–34CrossRef

Hollingsworth T (2002) Manufacturers alliance/MAPI survey of corporate tax departments, 4th edn. Manufacturers Alliance/MAPI, Arlington, VA

Jensen M, Murphy K (1990) Performance pay and top management incentives. J Polit Econ 98(2):225–264CrossRef

Jiménez-Angueira C, Stuart N (2015) Relative performance evaluation, pay-for-luck, and double-dipping in CEO compensation. Rev Quant Finance Account 44(4):701–732CrossRef

Keating AS (1997) Determinants of divisional performance evaluation practices. J Account Econ 24(3):243–273CrossRef

Lambert R, Larcker D (1987) An analysis of the use of accounting and market measures of performance in executive compensation. J Account Res 25(Supplement):85–129CrossRef

Lev B, Thiagarajan SR (1993) Fundamental information analysis. J Account Res 31(2):190–215CrossRef

Lim Y (2012) Tax avoidance and underleverage puzzle: Korean evidence. Rev Quant Finance Account 39(3):333–360CrossRef

Matolcsy Z (2000) Executive cash compensation and corporate performance during different economic cycles. Contemp Account Res 17(4):671–692CrossRef

Murphy K (1985) Corporate performance and managerial remuneration: an empirical analysis. J Account Econ 7(April):11–42CrossRef

Newman H (1989) Selection of short-term accounting-based bonus plans. Account Rev 64:758–772

Nwaeze E, Yang S, Yin Q (2006) Accounting information and CEO compensation: the role of cash flow operations in the presence of earnings. Contemp Account Res 23:227–265CrossRef

Phillips J (2003) Corporate tax-planning effectiveness: the role of compensation based incentives. Account Rev 78(3):847–874CrossRef

Rego S, Wilson R (2008) Executive compensation, tax reporting aggressiveness and future firm performance. Working Paper University of Iowa

Rego S, Wilson R (2012) Equity risk incentives and corporate tax aggressiveness. J Account Res 50(3):775–810CrossRef

Richardson V, Waegelein J (2002) The influence of long-term performance plans on earnings management and firm performance. Rev Quant Finance Account 18(2):161–183CrossRef

Robinson J, Sikes S, Weaver C (2010) Performance measurements of corporate tax departments. Account Rev 85(May):1035–1064CrossRef

Schmidt A (2006) The persistence, forecasting, and valuation implications of the tax change component of earnings. Account Rev 81(3):589–616CrossRef

Sloan R (1993) Accounting earnings and top executive compensation. J Account Econ 16(1–3):55–100CrossRef

Wilson R (2009) An examination of corporate tax shelter participants. Account Rev 84(3):969–999CrossRef

Titel: The executive compensation implications of the tax component of earnings
verfasst von: Victoria Hansen
Thomas J. Lopez
Austin Reitenga
Publikationsdatum: 10.03.2016
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 3/2017
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-016-0561-5

Springer Professional

Abstract

Bitte loggen Sie sich ein, um Zugang zu Ihrer Lizenz zu erhalten.

Sie haben noch keine Lizenz? Dann Informieren Sie sich jetzt über unsere Produkte:

Springer Professional "Wirtschaft+Technik"

Springer Professional "Wirtschaft"

Weitere Artikel der Ausgabe 3/2017

Corporate governance, ownership structure and managing earnings to meet critical thresholds among Chinese listed firms

Do political connections affect stock price crash risk? Firm-level evidence from China

The joint determinants of cash holdings and debt maturity: the case for financial constraints

On the value and determinants of the interest tax shields

The affine styled-facts price dynamics for the natural gas: evidence from daily returns and option prices

Recap of the 27th annual financial economics and accounting conference, September 30–October 1, 2016