Knowledge that Transforms

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.

This paper demonstrates that options can be used to eliminate agency costs in the formal agency model. When an agent's action can determine the mean of future cash flows assumed to follow a binomial random walk, the principal can design a compensation package using options which are hedged by other components of the compensation package to be risk-free only if the agent takes the action desired by the principal and therefore risky if the agent is shirking. Thus, a risk- (and effort-) averse agent can be given incentives to take the action desired by the principal without sacrificing optimal risk sharing, even when the agent's action cannot be observed, either directly or indirectly.

This paper presents additional evidence on the relation between the investment opportunity set and financing, dividend, and compensation policies. Our results are based on a sample of 237 growth firms and 237 nongrowth firms. We find that growth firms have significantly lower debt/equity ratios and exhibit significantly lower dividend yields than nongrowth firms. We also find that growth firms pay significantly higher levels of cash compensation to their executives and have a significantly higher incidence of stock option plans than nongrowth firms. However, controlling for firm size, the incidence of bonus plans, performance plans, and restricted stock plans does not differ between growth and nongrowth samples.

This paper employs an agency model where a manager has a two-dimensional action choice to study how the information content of earnings affects the design of compensation contracts based on earnings and price. Price is modeled as an endogenous variable that reflects all available information, including earnings. Two settings are contrasted. In the first, earnings and price reflect the same underlying information about firm value, while in the second, earnings reflect a subset of the information reflected in price. It is shown that differences in information content substantially alter the characteristics of compensation contracts based on earnings and price.

This paper investigates the role of accounting earnings in top executive compensation contracts. It provides evidence in support of the hypothesis that earnings-based incentives help shield executives from market-wide factors in stock prices. The paper demonstrates that earnings reflect firm-specific changes in value, but are less sensitive to market-wide movements in equity values. As a result, the inclusion of earnings-based performance measures in executive compensation contracts helps shield executives from fluctuations in firm value that are beyond their control. The hypothesis is shown to explain cross-sectional variation in the use of earnings-based incentives.

It is commonly observed that the compensation paid to senior level executives depends on both accounting and security price measures of performance. The articles by Kim and Suh, Bushman and Indjejikian, and Sloan, which I have been invited to discuss, examine the issue of how much weight to place on these two measures in the contract. The first two papers analyze the role that earnings can play in removing the ‘noise’ in stock price in a rational expectations pricing model. The Sloan paper analytically and empirically examines the role that earnings can play in removing macroeconomic factors from stock price.

In order to gain insights into possible cross-national differences in asymmetric information between managers and investors, we empirically assess differences in timing between the U.S. and the Japanese stock markets in impounding accounting information. Our findings indicating that the Japanese stock market incorporates information earlier than does the U.S. stock market are consistent with the hypothesis that Japanese investors, who tend to have close ties to the businesses they invest in, are better informed than their U.S. counterparts. We suggest, building on Stein's (1989) work on market signaling/jamming, that larger information asymmetries in the U.S. may be creating incentives for a short-run management style detrimental to long-term competitiveness.

This paper investigates the effects of the 1981 Research and Development (R&D) tax credit, first, by examining the impact of the credit on the level of R&D investment and, second, by estimating the magnitude of the implicit tax created by the credit. The two effects are interrelated because an increase in the level of R&D investment will increase the demand for R&D inputs, thus reducing the pretax rate of return from R&D activity.1 I test the credit's investment effect using a time-series R&D spending model that includes both factors from the industrial organization literature (to control for nontax effects) and an R&D credit usability variable to capture the incentive created by the credit. Previous research has produced mixed evidence on whether the credit had any positive

Kumar N. Sivakumar, Gregory Waymire, The Information Content of Earnings in a Discretionary Reporting Environment: Evidence from NYSE Industrials, 1905-10, Journal of Accounting Research, Vol. 31, No. 1 (Spring, 1993), pp. 62-91

Andrew Alford, Jennifer Jones, Richard Leftwich, Mark Zmijewski, The Relative Informativeness of Accounting Disclosures in Different Countries, Journal of Accounting Research, Vol. 31, Studies on International Accounting (1993), pp. 183-223