Alex Thevaranjan

The Shielding of CEO Compensation from the Effects of Strategic Expenditures

This study investigates whether and why compensation committees shield CEO compensation from income-decreasing effects of strategic expenditures. We document that firms do shield recurring expenditures such as research and development and advertising expenditures. We also find that firms shield research and development expenditures more than advertising expenditures. Our results are consistent with prior findings that suggest that compensation committees shield CEOs from non-routine transactions such as restructuring charges and extraordinary losses. Using a two-task principal-agent framework, we show that such shielding improves the efficiency of the contract by making the shielded income measure more congruent with the principals objectives.

Ethics and Agency Theory: Incorporating a Standard for Effort and an Ethically Sensitive Agent

We study the implications of introducing ethics into the traditional principal-agent model. In our model, the principal specifies a standard for effort at the time of contracting and the agent suffers a utility loss if he chooses not to provide the standard after agreeing to the contract. The magnitude of the loss depends upon the agents ethical sensitivity. We demonstrate the emergence of an optimal flat salary contract. We then examine the interplay between ethical sensitivity and firm productivity in determining the optimal salary contact, and contrast it with the traditional incentive solution. Our results are intuitive and help explain a variety of contracting behavior that is inconsistent with traditional agency predictions.

Returns to Scale Pattern and Efficient Firm Size in the Public Accounting Industry: An Empirical Investigation

This paper employs Data Envelopment Analysis to investigate returns to scale patterns and efficient firm size in the public accounting industry in the USA post-Sarbanes–Oxley Act. Using contemporary survey data from Accounting Todays top-100 accounting firms for the years 2003 and 2004, our results indicate that the very largest accounting (first tier) firms display constant returns to scale, whereas approximately half of the smaller (second tier) firms exhibit increasing returns to scale. These findings suggest that while very large firms are optimally scaled, there still are economic efficiencies to be gained through expanding the size of nearly half of the second-tier accounting firms. Results for the remaining second-tier firms show either constant or decreasing returns to scale, indicating that they are either already optimally sized or that they should consider contraction. The results for the second-tier firms remain qualitatively unchanged when the first-tier firms are excluded from the estimation.

Incentives and job redesign: the case of the personal selling function

Changes in the internal and the external environment of organizations are causing many of them to redesign individual jobs as team functions. Sales organizations, in particular, are responding to increased selling costs by redesigning the selling function to include a support person. The basic idea here is to let the support person perform important but relatively low-skilled tasks, such as lead generation, so that the salespersons valuable time is freed up to perform important and relatively high-skilled tasks, such as product promotion. However, this trend gives rise to several interesting questions. Specifically, we ask: How are the incentives offered to the salesperson affected by the introduction of the support person? To what extent will the support person be utilized? And, how will the job be conducted under the new design? We find that the level of incentives and job redesign are related, albeit in a complex manner. We also find that the firm will not always fully utilize the support person, nor will the salesperson always fully delegate the low-skilled task to him. We conclude by discussing the implications of our findings. Copyright

Current production targets and strategic decisions by corporate managers

Abstract This article considers the potential role of current production targets in providing corporate managers with incentives for allocating their efforts toward operational and strategic decisions. Operational decisions relate to current production, while strategic decisions affect both current production and future profitability. A moral hazard exists to the extent that manager effort allocations are not observable. Of interest is the design of compensation contracts which efficiently resolve that hazard. Attention is mainly focused on distortions in current production away from targets which would be optimal if manager effort allocations were observable. The principal insight is that an increase in current production targets may, paradoxically, be motivated by a desire to induce a greater allocation of effort to strategic decisions.

Is There Room within Principal-Agent Theory for Ethics?

We study the feasibility and desirability of integrating ethics with traditional principal-agent theory. After discussing common objections and potential benefits, we present a principal-agent model that incorporates ethics in a manner that maintains the essential features of the traditional LEN framework. In our integrative model, the principal specifies a standard for effort at the time of contracting and the agent suffers a disutility if he chooses to violate the standard after agreeing to the contract. The magnitude of the disutility depends upon the level of violation and the ethical sensitivity of the agent. Setting ethical sensitivity to zero yields the traditional result that a flat salary is incapable of inducing effort from the agent. When ethical sensitivity becomes nonzero, however, a flat salary solution emerges. We examine the interplay between ethical sensitivity and firm productivity in determining the optimal salary contract. Our study suggests that incorporating ethics enhances both the internal and external validity of principal-agent theory.

How to Deal with Unprofitable Customers? A Salesforce Compensation Perspective

We show that prices and incentives recommended by the salesforce literature when targeting a profitable segment can attract unprofitable customers, particularly when salespeople have high productivity and low risk (i.e., risk aversion times uncertainty). Therefore, when customers are unidentifiable, unprofitable customers may also enter the market creating an adverse selection problem for the salespeople. By solving the moral hazard and adverse selection problems simultaneously, we show that firms can prevent the entry of unprofitable customers by “screening”. Although, screening generally requires a higher price to dissuade unprofitable customers, when firms hire salespeople, however, it requires lowering of both selling effort and the price. It also leads to a “sales trap” restricting the sales to the profitable segment to a fixed level. Screening, therefore, lowers firm profits obtained from the profitable customers. When salespeople are highly productive and risk tolerant, this drop in profit can be so high that “accommodating” unprofitable customers becomes the preferred strategy. Furthermore, the adverse selection problem intensifies and accommodation becomes more preferable when there is no moral hazard between firm and the salesperson. Behavior of unprofitable customers, therefore, must be an important consideration when targeting high-value customers and designing salesforce compensation.

Impact of audit quality on the components of executive cash compensation

Purpose This paper aims to study the impact of audit quality on the components of executive cash compensation. It is predicted that as audit quality improves, greater emphasis will be placed on the incentive components of cash compensation, and lower emphasis on the salary (fixed) component. Specifically, it is predicted that as audit quality enhances, greater emphasis will be placed on earnings and sales revenues in determining executive cash compensation. Using auditor specialization as a proxy for audit quality, empirical support is provided for all of our predictions. Design/methodology/approach This paper provides empirical support with agency theoretic predictions. Findings This paper developed the following hypotheses: H1 – in executive cash compensation, more weight is being placed on earnings-based measures as auditor specialization improves; H2 – in executive cash compensation, more weight is also being placed on sales revenues as auditor specialization improves; H3 – in executive cash compensation, salary levels decrease as auditor specialization improves; and H4 – the impact of auditor specialization on the weight on earnings, sales and the salary levels is lower in the post-Sarbanes–Oxley Act (SOX) period compared to pre-SOX period. Research limitations/implications First, the article limits itself to cash compensation, while current executive compensation is largely made of equity. Second, the measure of audit quality used, ‘national level auditor specialization’, may not be as effective in the post-SOX era. Practical implications Compensation committees should pay attention to audit quality (in whatever way it may be proxied by) in determining executive compensation. Originality/value This is the first paper to show that audit quality not only improves the earnings response coefficient in firm valuation but also enhances the weight placed on earnings (and sales revenues) in executive compensation.

The role of non-financial measures in controlling myopic activities: the case of hard selling

Using a principal-agent framework, many analytical studies have examined the role of non-financial or additional performance measures in enhancing long-run efforts such as customer service. However, myopic activities that enhance short-term firm performance at the expense of long-term profitability are prevalent across industries (and perhaps nations). Accordingly, the purpose of this paper is to investigate when and how non-financial measures may be used to control such myopic activities. Specifically, we investigate the interaction between a myopic behaviour known as hard selling and a specific non-financial measure (customer satisfaction), often used to measure the customer irritation that results from hard selling. Prior studies suggest that non-financial measures are always a valuable addition because they increase the level of long-run efforts and decrease the (over) reliance on financial incentives. In contrast, we find that non-financial measures may not always be valuable in controlling myopic activities, and when valuable, they may either increase or decrease the reliance on a financial measure such as accounting earnings. In addition, the impact of non-financial measures on myopic activities varies widely, ranging from no impact at all to complete elimination. Overall, these insights enhance our understanding of the role of non-financial measures in controlling myopic activities, in contrast to enhancing long-run efforts.