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Rationality of executive compensation schemes and real accounting changes

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  • A. RASHAD ABDEL†KHALIK
  • CHARLES CHI
  • DIMITRIOS GHICAS

Abstract

. Managerial preference for accounting methods is examined with respect to the effects of the chosen methods on executives' annual compensation (salary and bonus). Two propositions are considered: (a) the bonus†hypothesis, and (b) the rationality of compensation schemes. While the former asserts a tie between compensation and accounting income, the latter stipulates a connection between the real (cash flow) consequences of the choice of accounting methods and executives' compensation. Two accounting method changes were used: (a) the change in pension costing and funding (which increases both income and operating cash flows), and (b) the change in inventory valuation method to LIFO (which decreases income and increases cash flows). Unexpected compensations in the switch†year were correlated with the effects of each accounting change on income. The results suggest that top executives' salary and bonus payments increased in the switch†year beyond levels predicted by the pre†switch compensation parameters. Several validation checks were also performed using comparison samples. Furthermore, the effects of these two accounting changes on income were found to correlate with unexpected compensation in the directions predicted by the hypothesis of rationality of compensation schemes. Résumé. Les préférences de la direction quant aux méthodes comptables sont examinées relativement aux effets des méthodes retenues sur la rémunération annuelle des dirigeants (salaries et gratifications). Deux propositions sont envisagées: (a) l'hypothèse de gratification, et (b) la rationalité des systèmes de rémunération. Alors que la première proposition affirme l'existence d'un lien entre la rémunération et le bénéfice comptable, la seconde est à l'effet qu'il existe une relation entre les conséquences réelles (flux de trésorerie) de la méthode comptable choisie et a rémunération des dirigeants. Deux types de changement de méthode comptable furent considérés: (a) le changement dans la comptabilisation des coûts et la capitalisation des régimes de retraite (augmentant à la fois le bénéfice comptable et le flux monétaire d'exploitation), et (b) le changement de méthode d'évaluation des stocks pour DEPS (diminuant e bénéfice comptable et augmentant les flux de trésorerie). Les rémunérations imprévues versées dans l'année où il y eut changement ont été corrélées aux effets de chaque modification comptable sur le bénéfice.

Suggested Citation

  • A. Rashad Abdel†Khalik & Charles Chi & Dimitrios Ghicas, 1987. "Rationality of executive compensation schemes and real accounting changes," Contemporary Accounting Research, John Wiley & Sons, vol. 4(1), pages 32-60, September.
    • Handle: RePEc:wly:coacre:v:4:y:1987:i:1:p:32-60
    DOI: 10.1111/j.1911-3846.1987.tb00654.x
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    Cited by:

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    2. Michael Ettredge & Jeong Youn Kim, 1994. "Dividend behavior surrounding LIFO adoption," Review of Financial Economics, John Wiley & Sons, vol. 4(1), pages 39-53, September.
    3. Duh, Rong-Ruey & Lee, Wen-Chih & Lin, Ching-Chieh, 2009. "Reversing an impairment loss and earnings management: The role of corporate governance," The International Journal of Accounting, Elsevier, vol. 44(2), pages 113-137, June.
    4. Ramachandran Ramanan & Bala V. Balachandran, 1993. "Management Compensation Surrounding an Accounting Change and Long†Term Construction Projects," Contemporary Accounting Research, John Wiley & Sons, vol. 10(1), pages 211-226, September.
    5. Chalevas, Constantinos G., 2011. "The Effect of the Mandatory Adoption of Corporate Governance Mechanisms on Executive Compensation," The International Journal of Accounting, Elsevier, vol. 46(2), pages 138-174, June.
    6. Comprix, Joseph & Muller III, Karl A., 2006. "Asymmetric treatment of reported pension expense and income amounts in CEO cash compensation calculations," Journal of Accounting and Economics, Elsevier, vol. 42(3), pages 385-416, December.

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