Pay Convexity, Earnings Manipulation, and Project Continuation
Year: 2014
Type: article
Abstract: ABSTRACT This paper studies the optimal design of long-term executive pay plans when boards of directors use accounting information for investment decision-making and executives can take costly actions to manipulate this information. The model predicts that a shift to more convex executive pay plans, such as equity plans that rely more on options and less on stock, is associated with higher levels of manipulation, lower reporting quality, and less efficient investment. When designing the optimal contract, the board trades off these effects with the cost of inducing executive effort. The paper also analyzes how the optimal pay convexity and the equilibrium level of manipulation change when the CEO's opportunistic reporting discretion changes. The model predicts that an increase in the CEO's marginal cost of manipulation increases the optimal level of pay convexity and first increases and then decreases the magnitude of manipulation. JEL Classifications: M12; M41; G31.
Source: The Accounting Review
DOI: 10.2308/accr-50843
Author: Volker Laux
Institution: The University of Texas at Austin
Language: English
Subfield: Accounting
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W2114267256