Carol A. Marquardt

Fundamentals of Accounting Losses

This paper examines accounting and non-accounting factors behind accounting losses over a fifty-year period. Using multivariate time-series analysis, we report evidence that the annual percentage of losses for U.S. firms is significantly related to accounting conservatism, Compustat coverage of small firms, real firm performance as measured by cash flows from operations, and business cycle factors. We further find that non-accounting factors tend to play the dominant role in explaining accounting losses over our sample period. Our results are robust to alternative definitions of macroeconomic productivity, as well as to varying model specifications. Our findings contribute to the literature on accounting losses and accounting conservatism and have implications for the use of accounting loss information in numerous settings.

Earnings Management through Transaction Structuring: Contingent Convertible Debt and Diluted Earnings per Share

In this article we examine whether firms structure their convertible bond transactions to manage diluted earnings per share (EPS). We find that the likelihood of firms issuing contingent convertible bonds (COCOs), which are often excluded from diluted EPS calculations under Statement of Financial Accounting Standard (SFAS) 128, is significantly associated with the reduction that would occur in diluted EPS if the bonds were traditionally structured. We also document that firms` use of EPS-based compensation contracts significantly affects the likelihood of COCO issuance and find weak evidence that reputation costs, measured using earnings restatement data, play a role in the structuring decision. These results are robust to controlling for alternative motivations for issuing COCOs, including tax and dilution arguments. In addition, an examination of announcement returns reveals that investors view the net benefits and costs of COCOs as offsetting one another. Our results contribute to the literature on earnings management, diluted EPS, financial reporting costs, and financial innovation.

The Cost of Employee Stock Option Grants: An Empirical Analysis

This study presents empirical evidence on the ex post costs of employee stock option (ESO) grants to issuing firms and examines whether the Black–Scholes [1973] model provides reasonable estimates of these values. Because there are no market prices for ESOs, the traditional avenues for testing option–pricing models are unavailable. This research relies instead on techniques from the economic forecasting literature, viewing model values as forecasts of the options’ payoff. The theoretically appropriate rate at which to discount ESO payoffs is derived under the maintained hypothesis that the Black–Scholes model is valid. This rate is used in estimating ex post ESO costs at the time of grant, which are then compared with Black–Scholes estimates using Theil’s [1966] tests of forecast rationality. Based on a sample of 966 ESO grants over 1963–1984, the results suggest that the Black–Scholes model, adjusted for concavity in the time to exercise using the Hemmer, Matsunaga, and Shevlin [1994] procedure, appears to provide reasonable estimates of ex post ESO costs for the average ESO grant. However, there is significant variability in the amount of model error on an individual grant basis.

Accelerated Share Repurchases, Bonus Compensation, and CEO Horizons

We examine whether short-term financial reporting objectives related to executive compensation and employment horizons affect managers’ decisions to undertake accelerated share repurchases (ASRs) versus open market repurchases (OMRs). In an ASR, the firm repurchases borrowed shares and simultaneously enters into a forward contract with an investment bank. This structure provides potential financial reporting advantages over OMRs in that earnings per share (EPS) benefits are recorded immediately (i.e., the reporting effects are “accelerated”) while the actual share repurchases and potential costs associated with the forward contract are deferred to a future date. Consistent with this short-term focus, we find that firms are more likely to choose ASRs over OMRs when the repurchase is accretive to EPS, when annual bonus compensation is explicitly tied to EPS performance, when CEO horizons are short, and when CEOs are more entrenched. These results are robust to controlling for endogeneity in the decision to repurchase shares. In addition, we find no evidence that compensation committees adjust executive pay for the effects of the ASR. Overall, our results suggest that short-term financial reporting benefits are a significant determinant of decisions to undertake ASRs, consistent with theories of managerial myopia.

M&A Decisions and US Firms’ Voluntary Adoption of Clawback Provisions in Executive Compensation Contracts: M&A DECISIONS AND CLAWBACK PROVISIONS

We examine whether US firms’ M&A decisions influence the likelihood of voluntary adoption of clawback provisions in executive compensation contracts and whether clawback adoption improves subsequent M&A decisions. Because prior research finds that poor M&A decisions are associated with future earnings restatements, we predict that clawback adoption is more likely after these transactions. We further conjecture that M&A decisions will improve after clawback adoption, as its presence reduces executives’ willingness to manipulate post�?acquisition earnings. Consistent with our expectations, we find that (1) firms with more negative M&A announcement returns are more likely to adopt clawbacks; (2) firms that acquire targets with relatively poor accounting quality are more likely to adopt clawbacks; (3) clawbacks improve investor perception of M&A quality; and (4) executives are more responsive to the market when completing M&A deals if their compensation contracts include clawbacks. These results suggest that boards take a pro�?active approach and consider factors that may lead to restatements when adopting clawbacks. Our results have implications for US policymakers, as the Dodd�?Frank Act of 2010 requires mandatory adoption of clawbacks. Our results also suggest that non�?US firms can reduce managerial incentives to manipulate post�?takeover earnings by using clawbacks.

Using Sales Revenue as a Performance Measure

This study provides the first systematic examination of the compensation contracting relevance of sales revenue. We document an increasing temporal trend in the explicit use of sales revenue as a performance measure in CEO annual bonus contracts, which is mirrored by a similar increase in the relative pay-sensitivity of revenues versus earnings over time. We also predict and find that sales revenue is more likely to be used as an explicit performance measure in annual bonus contracts when sales revenue is relatively more informative about firm value than accounting earnings and when firms follow a growth-focused organizational strategy. In addition, we find that the pay-sensitivity of revenue is significantly more positive for firms that explicitly reward revenue performance, as expected, but also that earnings pay-sensitivity is not significantly different from zero for these firms. This paper extends our current understanding of the selection of performance measures in compensation contract design and raises new questions about the validity of the traditional implicit tests in examining questions related to executive pay.