Knowledge that Transforms

This study analyses the relation between cash compensation of bank CEOs and accounting earnings from selected discretionary transactions. Results indicate that income from discreationary transactions accompanied by cash flow effects is reflected in the CEO compensation function. There is no reliable indication that income from discreationary transactions unaccompanied by cash flows affects compensation. The impact of discreationary earnings on the compensation function varies as a function of firms' ‘nonperforming loans’. We interpret nonperforming loans as a proxy for the firm's future capital position. There is no support for a tax-based explanation for the link between compensation and discreationary earnings.

This paper provides evidence on the cross-sectional relation between firms' investment opportunities, their debt and compensation contracts, their size and financial leverage, and their accounting procedure choices. This evidence is important, because previous studies hypothesize that the link between firms' investment opportunities and their accounting choices helps explain extant results on the size, debt/equity, and bonus plan hypotheses. However, while I find that firms' investment opportunities do affect the nature of their contracts. I also find that the ‘traditional’ explanations for accounting choice are important after controlling for the effects of the investment opportunity set.