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Incentive Contracting and Value Relevance of Earnings and Cash Flows

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  • RAJIV D. BANKER
  • RONG HUANG
  • RAMACHANDRAN NATARAJAN

Abstract

Accounting performance measures such as earnings and cash flows are useful for both valuation and performance evaluation purposes. However, little evidence exists on whether there is any association between these two roles. In this study, we provide large sample empirical evidence that the value relevance of earnings explains a significant amount of the cross‐sectional variation in the pay‐sensitivity of earnings and the incremental value relevance of cash flows explains variation in the marginal pay‐sensitivity of cash flows. We document that while both value relevance and compensation weight on earnings decline from the subperiod of 1993 to 1997 to the subperiod of 1998 to 2003, both value relevance and compensation weight on cash flows increase from the earlier subperiod to the later subperiod. Overall, our results provide additional evidence that value relevance of a performance measure plays a significant role in its use for performance evaluation.

Suggested Citation

  • Rajiv D. Banker & Rong Huang & Ramachandran Natarajan, 2009. "Incentive Contracting and Value Relevance of Earnings and Cash Flows," Journal of Accounting Research, Wiley Blackwell, vol. 47(3), pages 647-678, June.
    • Handle: RePEc:bla:joares:v:47:y:2009:i:3:p:647-678
    DOI: 10.1111/j.1475-679X.2009.00335.x
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