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Asymmetric sensitivity of executive bonus compensation to earnings and the effect of regulatory changes

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Abstract

In this paper we examine the sensitivity of CEO bonus to earnings in the cases of good news and bad news, and compare these relationships in the periods before and after SOX. We find an asymmetric sensitivity of bonus to earnings. We also find that the asymmetric sensitivity of bonus to earnings exists before SOX but disappears post SOX. Regulatory changes brought forth by SOX, including personal certifications of financial reporting by CEOs and CFOs, the claw back provision, annual evaluation of internal controls and disclosure of any material weakness, and increased level of conservatism in firms and their auditors after SOX, offer an alternative mechanism to monitor executives, potentially reducing the ex post settling up problem. The findings show that regulatory changes affect compensation contracts and have implications for regulators, managers, politicians, investors, and academics in their assessment of the equitable relationship between executive efforts and executive bonus compensation.

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Notes

  1. Leone et al. (2006) further note that the ex post settling up problem also exists in other types of CEO compensation, although it is likely to be more severe when payments are made in cash.

  2. https://www.sec.gov/news/press/2011/2011-243.htm.

  3. As in Leone et al. (2006), negative (positive) market-adjusted stock returns are used as a proxy for unrealized losses (gains) or bad (good) news.

  4. Leone et al. (2006) also indicate that if the firm pays the executive a cash bonus for an unrealized gain, but that gain does not later materialize, the executive can quit the firm and the shareholders will have difficulty recovering the cash paid for that unrealized gain.

  5. When we use annual raw return to classify good/bad news firms, the sample consists of 3557 (1775) good news (bad news) firms.

  6. Although not shown in the table, other performance variables, such as ANNMAR, ΔROE, and ΔEPSEIP, are also positively and significantly correlated with ΔBON.

  7. Leone et al. (2006) present their empirical results based only on Fama–MacBeth regression tests.

  8. High level of NOAA indicates low level of conservatism.

  9. For example, as shown in Carters et al. (2009), the NYSE proposed significant rule changes in its listing standards aimed at ensuring independence of directors and strengthening corporate governance practices of listed companies. In October 2002, the NASDAQ followed suit with a similar proposal to strengthen board independence and committee independence.

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Acknowledgements

We’d like to thank Steve Balsam, Patrice Gelinas, David Kwon, Gerry Lobo, Bharat Sarath, Inho Suk, and participants at the 2018 Annual Conference on Pacific Basin Finance, Economics, Accounting, and Management, 2015 Canadian Academic Accounting Association Annual Meeting, and 2012 American Accounting Association Annual Conference for their helpful comments.

Data Availability

Data used in this study are available from public sources identified in the paper.

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Authors and Affiliations

  1. School of Administrative Studies, Faculty of Liberal Arts and Professional Studies, York University, Toronto, M3J 1P3, Canada

    Sung S. Kwon

  2. College of Business, University of Texas at San Antonio, San Antonio, TX, 78249-0632, USA

    Jennifer Yin

  3. LeBow College of Business, Drexel University, Philadelphia, PA, 19104-2875, USA

    Gordian A. Ndubizu

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  1. Sung S. Kwon
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  2. Jennifer Yin
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  3. Gordian A. Ndubizu
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Correspondence to Jennifer Yin.

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Kwon, S.S., Yin, J. & Ndubizu, G.A. Asymmetric sensitivity of executive bonus compensation to earnings and the effect of regulatory changes. Rev Quant Finan Acc 53, 845–869 (2019). https://doi.org/10.1007/s11156-018-0768-8

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