Dual signals of future performance: how will the compensation committee respond?

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University of Alabama Libraries

Pay-for-performance is an important contracting tool available to mitigate agency costs. Matsunaga and Park (2001) suggest CEOs of firms that meet or beat (miss) the analysts' forecast receive a bonus compensation premium (discount) in affirmation of a pay-for-performance relation based on extant literature that suggests meet or beat firms outperform miss firms. However, Bhojraj, Hribar, Picconi, and McInnis (2009) more recently suggest miss firms with a positive signal of future performance outperform beat firms with a negative signal of future performance. I extend Matsunaga and Park (2001) by examining the incremental contribution of a positive/negative future performance signal in the determination of CEO bonus compensation to determine if the pay-for-performance relation holds, particularly for the subset of firms with conflicting analysts' forecast/future performance signals. Generally, my hypotheses predicting the future performance signal will incrementally contribute to the determination of bonus compensation are unsupported. This result is consistent with a breakdown in the pay-for-performance relationship attributable to either a myopic focus on an earnings threshold signal or an inability to interpret the future performance signal. Alternately, this result could also suggest the firm considers the cost of missing the forecast to be greater than the cost associated with a decline in future performance.

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