[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.]

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.