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CEO Compensation Risk and Timely Loss Recognition

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  • Paul Brockman
  • Tao Ma
  • Jianfang Ye

Abstract

Prior studies demonstrate that high CEO compensation risk encourages managers to engage in risk-seeking behavior, thus intensifying agency conflicts between creditors and borrowers. We argue and document that accounting conservatism plays an important role in mitigating debt holder and shareholder conflicts over asset substitution arising from high CEO compensation risk. Our empirical results show that firms with high CEO compensation risk tend to use more timely loss recognition and this positive relationship is more pronounced for firms with high leverage. Additional results show that the positive relationship between CEO compensation risk and borrowing costs is reduced for firms using timely loss recognition, suggesting that creditors perceive timely loss recognition as a risk-reducing mechanism. Using the passage of FAS 123R as a quasi-natural experiment on managerial compensation risk, we find a significant reduction in the use of timely loss recognition for firms experiencing a decrease in CEO compensation risk after the passage of FAS 123R. Lastly, we show that timely loss recognition is positively associated only with the compensation risk of the firm's primary decision maker (i.e., its CEO) and not with the compensation risk of subordinates.

Suggested Citation

  • Paul Brockman & Tao Ma & Jianfang Ye, 2015. "CEO Compensation Risk and Timely Loss Recognition," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 42(1-2), pages 204-236, January.
    • Handle: RePEc:bla:jbfnac:v:42:y:2015:i:1-2:p:204-236
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    File URL: http://hdl.handle.net/10.1111/jbfa.12100
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    2. Khalifa, Mariem & Trabelsi, Samir & Matoussi, Hamadi, 2022. "Leverage, R&D expenditures, and accounting conservatism: Evidence from technology firms," The Quarterly Review of Economics and Finance, Elsevier, vol. 84(C), pages 285-304.
    3. Avishek Bhandari & Babak Mammadov & Maya Thevenot, 2018. "The impact of executive inside debt on sell-side financial analyst forecast characteristics," Review of Quantitative Finance and Accounting, Springer, vol. 51(2), pages 283-315, August.
    4. Wenxia Ge & Jeong‐Bon Kim, 2020. "How does the executive pay gap influence audit fees? The roles of R&D investment and institutional ownership," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 47(5-6), pages 677-707, May.
    5. Rui Wang, 2021. "The attention of long‐term institutional investors and timely loss recognition," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 48(9-10), pages 1596-1629, October.
    6. Cui, Xin & Ma, Tingting & Xie, Xiaochen & Goodell, John W., 2023. "Uncertainty of uncertainty and accounting conservatism," Finance Research Letters, Elsevier, vol. 52(C).
    7. Chengru Hu & Wei Jiang, 2019. "Managerial risk incentives and accounting conservatism," Review of Quantitative Finance and Accounting, Springer, vol. 52(3), pages 781-813, April.
    8. Joohyung Ha, 2021. "Bank accounting conservatism and bank loan quality," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 48(3-4), pages 498-532, March.

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