Investigating Ceo Compensation and How

Abstract:

The purpose of this paper is to gain a further understanding into how CEO’s get compensated, and how they use accounting choices to maximize their compensation, often at the expense of shareholders. It is based off the findings of a paper by Fields, Lys and Vincent on accounting choice, which covers the issue of earnings management and executive compensation. My paper aims to look at the different types of accounting choices, and means of manipulation that CEO’s use to influence their compensation. Although I have done no quantitative analysis to prove it, I have attempted to acquire sufficient information to show that there are incentives for CEO’s to manipulate earnings for personal gain.

Introduction:

Throughout our Seminar in accounting course, we have frequently come across the issue of management compensation and accounting choice. One area that stirred a lot of interest, particularly with me, was that of CEO compensation. Are CEO’s really out there for the shareholder, or are they mainly trying to satisfy their own interest? There may be a conflict of interest, as the CEO is supposed to maximize shareholder value, but at the same time, by having incentives to increase his/ her compensation, they do not have their shareholders’ interest at heart. This paper will look at how CEO’s are compensated, and analyze those components of CEO compensation contracts that most influence the extent of analyst guidance (in particular stock and option ownership). The paper will also examine how CEO’s manage to manipulate earnings, and how this is done.

How are CEO’s compensated?

In order to fully understand how the CEO’s manage to manipulate earnings, it is important to first understand how they get compensated, and where there are incentives to manipulate earnings by using accounting choice.

According to the SEC , here are some of the main compensation methods for CEO’s. In order to help the reader understand areas focused on in my paper, I have expanded some of the methods mentioned below:

• Salary: CEO salaries are usually set on an annual basis. Moreover, it is a stylized fact that firm’s size is associated with base salary (Murphy, 1999).

• Bonus: These are a highly firm-specific and evaluate performance measures, performance standards, and the structure of the pay-performance relation (Murphy, 1999)

• Perks and other personal benefits, securities or property

The following are most subject to earnings manipulation, and will be the focus of my paper:

• Stock: