Compensation goals and firm performance∗

Using a large dataset of performance goals employed in executive incentive contracts we find that a disproportionately large number of firms exceed their goals by a small margin as compared to the number that fall short of the goal by a similar margin. This asymmetry is particularly acute for earnings and profit goals, when compensation is contingent on a single goal and is present for both long-term and short-term goals, when the pay-for-performance relationship is concave or convex and for grants with cash or stock payout. Firms that exceed their compensation target by a small margin are more likely to beat the target the next period and CEOs of firms that miss their targets are more likely to experience a forced turnover. Firms that just exceed their EPS goals have higher abnormal accruals and lower Research and Development (R&D) expenditures and firms that just exceed their profit goals have lower SG&A expenditures. Overall, our results highlight some of the costs of linking managerial compensation to specific compensation targets. JEL Classification: G30, J33 ∗We thank an anonymous referee, Felipe Cortes, the seminar participants at Northeastern University, Olin Business School and University of Amsterdam for helpful comments. †Assistant Professor, Air Force Institute of Technology. Corresponding author. e-mail: [email protected]. ‡Research Professor of Finance, W.P. Carey School of Business, Arizona State University §Associate Professor, Olin Business School, Washington University ¶Hubert C. and Dorothy R. Moog Professor of Finance, Olin Business School, Washington University in St. Louis. “Charlie and I believe that those entrusted with handling the funds of others should establish performance goals at the onset of their stewardship. Lacking such standards, managements are tempted to shoot the arrow of performance and then paint the bull’s-eye around wherever it lands.”