[This study investigates the role of alternative earnings components in the CEO cash compensation function. We find that cash compensation is significantly positively related to above the line earnings, as long as results are positive. Compensation is shielded from the effects of above the line losses. Similarly, nonrecurring transactions that increase income flow through to compensation, but nonrecurring losses do not. This effect is noted for gains and losses that arise both from extraordinary transactions, discontinued operations and nonrecurring items that do not qualify for below the line presentation. Thus, the data tell a remarkably consistent story: gains flow through to compensation, but losses do not. The classification of the gain or loss on the income statement is of relatively little importance.]

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 study examines the stock market reaction to the adoption of long-term compensation agreements for top management that are based on accounting goals. Prior researchers (Baril 1988; Larcker 1983; Smith and Watts 1982) argue that these agreements, known as performance plans, motivate executives to improve firm performance by working harder, lengthening their decision horizons, and becoming less risk-averse in their investment decisions. However, because the agreements are based on accounting goals, performance plans can distract managerial attention from the maximization of share price and can also encourage the manipulation of the accounting system (Gibbons and Murphy 1989). Managers may also reject projects with large, positive net present values in favor of less valuable projects with higher accounting profits. In an earlier study, Larcker (1983) reports a significantly positive stock market reaction for a sample of 21 firms that adopted performance plans between 1971 and 1978. The reaction occurs on the trading day after the SEC receives the proxy statement announcing the plan adoption. However, we find no significant reaction during the two-day announcement period beginning with the SEC stamp date for a sample of 209 adoptions that occur between 1971 and 1980. Further, no evidence of abnormal stock performance is detected for the two-day periods beginning with either the date on which the board of directors voted to approve the plan or the proxy statement date. Our study highlights the difficulties inherent in analyzing the stock market reaction to announcements made in proxy statements. First, pinpointing the timing of information dissemination is problematic. Second, firm-specific information unrelated to the event of interest is often released in the proxy statement and at the annual meeting. This complicates the interpretation of any unusual stock price behavior. In our study, significantly positive abnormal performance is observed for both adopting and nonadopting firms during the period beginning two days after the SEC stamp date and ending the day after the shareholders' meeting date. This suggests that the reaction observed for the adopting firms is due to the impending shareholders' meeting rather than to the performance plan adoption per se. We suggest that the results of any event study involving announcements made around the time of the annual shareholders' meeting should be interpreted with caution.]

This study investigates the rote of alternative earnings components in the CEO cash compensation function. We find that cash compensation is significantly positively related to above the line earnings, as long as results are positive. Compensation is shielded from the effects of above the line losses. Similarly, nonrecurring transactions that increase income flow through to compensation, but nonrecurring losses do not. This effect is noted for gains and losses that arise both from extraordinary transactions, discontinued operations and nonrecurring items that do not qualify for below the line presentation. Thus, the data tell a remarkably consistent story: gains flow through to compensation, but losses do not. The classification of the gain or loss on the income statement is of relatively little importance.

Examines the stock market reaction to the adoption of long-term compensation agreements for top management that are based on accounting goals. Method of study; Reaction observed for the adopting firms due to the impending shareholders' meeting rather than to the performance plan adoption per se; Caution in the interpretation of announcements made around the time of the annual shareholders' meeting.

We extend Healy (1985) by examining the relation between discretionary accruals and bonus plan bounds for a sample of 102 firms for the 1980–1990 period. Contrary to Healy, we find that when earnings before discretionary accruals fall below the lower bound, managers select income-increasing discretionary accruals (and vice versa). We believe that our results are more consistent with the income smoothing hypothesis than with Healy's bonus hypothesis. However, mechanical selection bias in portfolio formation cannot be entirely ruled out as an alternative explanation for our results.

We analyze the loss-reserving practices of 562 insurance companies in 1993 to assess the relation between client influence and auditor oversight. Consistent with Petroni [1992. Management's response to the differential costs and benefits of optimistic reporting in the property-casualty insurance industry. Journal of Accounting and Economics 15, 485–508.], we find that financially struggling insurers tend to under-reserve. However, this behavior is attenuated when the weak insurer is important to the local practice office of the auditor. This result holds across various measures of client influence and supports the contention of Reynolds and Francis [2001. Does size matter? The influence of large clients on office-level auditor reporting divisions. Journal of Accounting and Economics 30, 375–400.] that auditors allow less accounting discretion to their larger clients.

We report that insurance firms manage loss reserves to avoid violating certain test ratio bounds (known as IRIS ratios) that are used by regulators for solvency assessment. In our sample, almost two-thirds of the firms that would violate four or more IRIS ratios successfully adjust reserves to reduce the reported number of violations to less than four. This finding is significant because four violations usually trigger regulatory intervention. Our results indicate that non-earnings goals are an important influence on discretionary accounting choice. They also suggest that reserve manipulation can postpone needed regulatory intervention, sometimes for an extended period.

This study investigates the extent to which property‐casualty insurers select levels of loss reserves, net capital gains, and net stock transactions to meet solvency and tax reporting goals. Insurer solvency is reflected in financial measures known as IRIS (Insurance Regulatory Information System) ratios. IRIS ratios are generally enhanced by underestimating loss reserves, accelerating the realization of capital gains, postponing the realization of capital losses, issuing stock, and cutting dividends. Taxable income is reduced by reporting higher reserves and lower net capital gains on investments. We use simultaneous equations to model the three discretionary choices individually, while controlling for potential tradeoffs among the decisions. During the sample period of the study (1990‐95), there is a shift in the regulatory environment that we argue tends to reduce incentives to meet IRIS goals. Specifically, risk‐based capital (RBC) requirements were adopted in 1994. Although IRIS ratios continued to be used for solvency screening, their effect is expected to be diluted in the post‐RBC period. Our results provide qualified support for this claim. Evidence of the phenomenon is stronger when the choice variables are net capital gains and stock transactions, and weaker when loss reserves are considered. Two of the three discretionary choices affect taxable income: loss reserves and capital gains. We find that tax incentives are significantly associated with the loss reserve estimate throughout the sample period. In contrast, our results are only weakly consistent with the view that capital gains are timed to achieve tax relief.