Academic journal article IUP Journal of Organizational Behavior

Use of Non-Financial Performance Measures in Managers' Compensation Contracts as Earnings Management Constraints

Academic journal article IUP Journal of Organizational Behavior

Use of Non-Financial Performance Measures in Managers' Compensation Contracts as Earnings Management Constraints

Article excerpt

Earnings management literature argues that managers' compensation contracts are based on Financial Performance Measures (FPM). Indeed, the accounting earnings have been the subject of several studies. A few of them have attempted to check whether to introduce the Non-Financial Performance Measures (NFPM) as a constraint on earnings management. The aim of this paper is to empirically test the impact of NFPM on earnings management behavior. Our sample consists of 89 Canadian listed firms pertaining to three sectors for the period, 1997-2006. The results are conclusive and showed that there is a negative relationship between Discretionary Accruals (DA) as a proxy for earning management and the relative importance of NFPM in managers' compensation contracts, suggesting that NFPM acts as an additional earnings management constraint.

(ProQuest: ... denotes formulae omitted.)

Introduction

The use of Financial Performance Measures (FPM) in managers' compensation contracts is largely documented in earnings management literature (Healy, 1985; DeAngelo, 1986; and Gaver et al., 1995). Most related studies focus on the link between accounting figures and earnings management behavior, whereas a few researchers used Non-Financial Performance Measures (NFPM) in managers' compensation contracts in order to check earnings management patterns. The aim of this paper is to clarify if the existence of NFPM in managers' compensation contracts has a negative effect on opportunistic earnings management behavior. Firm managers have always motivations for earnings management in order to maximize firm value. Compensation contracts are always implicitly indexed to firm performance. However, many factors can limit managers' opportunistic behavior such as corporate governance structures (Dechow et al., 2008), past earnings management trends (Barton and Simko, 2002) and audit quality (Beker and Defond, 1998). Our contribution consists in checking the impact of some NFPM on managers' recourse to opportunistic earnings management.

Studies on positive accounting theory can be classified into two main streams: earnings management motivations which are largely developed (Healy, 1985; DeAngelo, 1986; Jones, 1991 ; Teoh eta!., 1998; and Degeorges eta!., 1999); and earnings' management constraints which are less developed. Our study is one of the fewer studies which address directly the question of earnings management constraints (see also Barton and Simko, 2002). More narrowly, we plan to answerthe following question: Do NFPM in managers' compensation contracts constrain opportunistic earnings management behavior?

We use annual compensation contracts for two main reasons: first, many studies focus on short-term compensation rather than long-term investments; second, a few studies have documented the relationship between NFPM and earnings management behavior. We assume that the use of NFPM in managers' compensation contracts minimizes earnings management as measured by the absolute value of Discretionary Accruals (DA).

In our study, we used a multivariate regression analysis that uses discretionary accruals as a dependent variable and the relative weight of NFPM as exogenous variable along with other control variables. Data are collected from the SEDAR database for the period 1997 to 2006. Our results confirm that the use of NFPM in compensation contracts is a constraint for earnings management.

The rest of the paper is organized as follows: first, we present a theoretical background of the literature related to the link between earnings management and NFPM in managers' compensation contracts; second, we formulate our research hypothesis; third, we describe data collection, methodology and some econometric issues; fourth, we present models' estimations and discuss our results; and finally, we conclude the paper pointing out the limitations.

Literature Review

Recent accounting literature is concerned which accounting figures disclosed by firms. …

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