Melbourne Accounting Research Seminar - Associate Professor Yong Zhang

Associate Professor Yong Zhang from Hong Kong Polytechnic presented a MARS seminar.

Topic: Direct Evidence on Non-GAAP Earnings Used in Executive Compensation Contracts

Abstract: This paper provides direct evidence on the properties of actual accounting earnings that are used in determining compensation payouts (Compensation Earnings). Using a large sample of manually collected Compensation Earnings for U.S. firms, we show that firms make economically significant adjustments to GAAP Earnings in arriving at Compensation Earnings. While we show that GAAP Earnings exhibit conditional conservatism (asymmetric timeliness in loss recognition), we fail to detect conditional conservatism in Compensation Earnings using the same sample and the same research design. Further analyses indicate that the adjustment from GAAP Earnings to Compensation Earnings involves the removal of less persistent components of GAAP Earnings, which results in Compensation Earnings that are more persistent than GAAP Earnings.
Given the multiple desirable characteristics of accounting performance measures proposed in the literature, Lambert (2010) suggests that it is interesting to examine the trade-off among them. This study adds to the literature of executive compensation by providing direct empirical evidence on the trade-off of two important features of accounting performance measures, namely conditional conservatism and persistence. We also contribute to the ongoing discussion on the explanations and implications of the widely documented conditional conservatism in GAAP Earnings.