The effect of accounting based bonus plan incentives on managers' financial reporting behavior and analysts' forecast accuracy
Abstract
Prior research on determinants of a firm's accounting policy decisions indicates an association between accounting earnings based bonus plans and discretionary reporting behavior by managers. However, little has been studied concerning implications of the bonus plan incentives beyond the accounting choice issue. This study examines the impact of management compensation information on the formation of earnings expectations. This study is based on the managerial accrual choice hypothesis suggested by Healy (1985) and extends the implications of his research to financial analysts' earnings forecast process. Healy shows that managers, in some situations, have an incentive to decrease reported earnings because of bonus bound effect. Accordingly, this study constructs and tests the accrual expectations hypothesis to see if there is a systematic difference in forecast accuracy of analysts' annual earnings forecasts because of the discretionary accrual choice by managers and analysts' expectations of the managerial behavior. More specifically, it is hypothesized that analysts' incorrect forecasts of the direction of managers' discretionary accrual choice lead to greater earnings forecast errors when forecasted earnings and actual earnings are separated by the bonus lower bound than when forecasted earnings and actual earnings are separated by the bonus upper bound. Empirical results of the study, which are based on alternative models and testing methodologies, generally support the accrual expectations hypothesis. A contribution of this study is that it provides evidence that the bonus information disclosed in corporate proxy statements have informational value to investors and analysts in forming earnings expectations and, thus proxy disclosure of the bonus information has the potential information content in mapping unexpected earnings into stock prices.
Degree
Ph.D.
Advisors
Schroeder, Purdue University.
Subject Area
Accounting
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