The structure and incentive properties of CEO bonuses : do annual CEO bonus plans spur earnings management?

Abstract

I investigate whether and when do annual bonus plans incite CEOs to manage short-term performance. I employ a large hand-collected dataset of detailed CEO bonus plan features that allows me to link ex-ante bonus schemes with their actual pay-outs. I show that CEOs manage earnings downwards whenever bonuses become insensitive to marginal performance (i.e. below minimum and above maximum payout thresholds) and upwards otherwise. This pattern is particularly pronounced for larger bonus plans and when corporate governance is weak. In additional tests, I rule out the possibility that this behavior is driven by CEOs' incentives to smooth earnings. The novel dataset also allows me construct measures of the ex-ante strength and relative importance of bonus driven incentives and to investigate the factors influencing the ex-ante structure of the bonus plan as well as the determinants and consequences of voluntary bonus disclosures. Finally, I also leverage my dataset to re-investigate prior findings on the pay-for-performance sensitivity of cash pay and find evidence suggesting that results documented in prior literature are mechanically driven by ex-ante bonus plan structure. The investigation of the incentive consequences of bonus plans is particularly timely given that recent regulatory changes render bonus pay relatively more favourable to companies at the expense of equity pay and bonus pay is expected to proliferate.