How Does Residual Income Affect Investment? The Role of Prior Performance Measures
This paper examines whether "you get what you pay for" in firms that implement residual income (RI)-based compensation. Specifically, this paper explores differences in investment patterns of firms that implement RI-based compensation plans conditional on whether the firms switched from earnings or return on investment (ROI)-based compensation. I find that the pattern of investment for firms switching to RI from earnings-based compensation is opposite to that of firms switching from ROI-based compensation. Changes in investment within each individual subgroup yield weaker, mixed results. In addition, this paper documents that delivered RI increases in firms that implement RI. My paper contributes to the literature on the investment effects of RI by examining the relevance of a set of arguments that have been made in management accounting textbooks since 1965. These arguments are still found in current textbooks and are commonly taught to students in graduate level managerial accounting classes. The arguments help us to examine a natural experiment in which we can better specify the conditions under which RI use is expected to be associated with changes in investment.
Volume (Year): 52 (2006)
Issue (Month): 3 (March)
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- Gerald T. Garvey & Todd T. Milbourn, 2000. "EVA versus Earnings: Does it Matter which is More Highly Correlated with Stock Returns?," Claremont Colleges Working Papers 2000-52, Claremont Colleges.
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- Rogerson, William P, 1997. "Intertemporal Cost Allocation and Managerial Investment Incentives: A Theory Explaining the Use of Economic Value Added as a Performance Measure," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 770-95, August.
- Larcker, David F., 1983. "The association between performance plan adoption and corporate capital investment," Journal of Accounting and Economics, Elsevier, vol. 5(1), pages 3-30, April.
- Wallace, James S., 1997. "Adopting residual income-based compensation plans: Do you get what you pay for?," Journal of Accounting and Economics, Elsevier, vol. 24(3), pages 275-300, December.
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