A cross-sectional analysis of cash compensation paid to CEOs of 713 US firms reveals that the sensitivity of compensation to earnings varies directly with earnings persistence. Additional analysis indicates that this sensitivity is greater for cases where executives are approaching retirement. Such evidence suggests the use of earnings persistence to counterbalance adverse consequences of earnings-based contracting with managers who face finite decision horizons.

We extend the contracting paradigm advanced in Smith and Watts (1992) to consider cross-sectional associations between investment opportunities and the sensitivity of CEO compensation to performance measures. We predict stronger associations between compensation and performance for firms with greater investment opportunities. We also predict greater use of market-based, rather than accounting-based, performance indicators as a basis for incentive payments when investment opportunities are substantial components of firm value. Results for specifications of 1992 and 1993 changes in compensation paid to CEOs of 1,249 publicly-traded U.S. firms are consistent with these hypotheses.

This paper examines the effect of accounting procedure changes on cash salary and bonus compensation to CEOs. We estimate whether there is an adjustment to the statistical relation between compensation and corporate earnings following changes that lower earnings (FIFO to LIFO inventory valuation) and that raise earnings (accelerated to straight-line depreciation). The results indicate that (1) subsequent to these changes salary and bonus payments are based on reported earnings, rather than earnings under the original accounting method, and (2) the potential compensation effect of the changes is small compared to the effect of economy- or industry-wide changes in compensation.