Parvez R. Sopariwala

The Effect of Adoption of Long-Term Performance Plans on Stock Prices and Accounting Numbers

Long-term performance plans are theoretically adopted to better align the interests of the managers and stockholders by redirecting managerial decision-making toward the longterm performance of the corporation. This study reports significant positive excess returns around the announcement of performance plan adoption, which is consistent with the view that such plans would reduce the agency problem. In addition, this study finds an association between the adoption of long-term performance plans and subsequent growth in profitability, suggesting that long-term performance plans may have been successful in motivating an enhancement in the accounting measures of profitability used to reward managers under the plan. Finally, the excess returns around the announcement of performance plan adoption are found to be positively correlated with subsequent change in growth of earnings per share, the most commonly used accounting performance measure.

An agency analysis of the effect of long-term performance plans on managerial decision making

Abstract Existing literature documents a positive stock market reaction to the announcement of long-term performance plans as well as subsequently higher growth rates in earnings per share and return on equity (ROE). These findings are consistent with the notion that such performance plans provide an incentive to managers to reduce the magnitude of agency conflict present within the modern corporation. Using a paired sample design, this paper addresses the specific sources of superior post-adoption ROE performance. We fail to observe any evidence of improvement in total sales, total asset turnover or the management of long-term debt. We find that the post-adoption increase in ROE growth is primarily attributable to improved profit margins, which in turn is a result of a lower Cost Of Goods Sold (COGS) and reduced inventory related costs. Specifically, we observe lower inventory size and a greater inventory turnover in the post-adoption period. We further report a reduction in short-term debt usage, which is consistent with lower inventory related costs. We also find that the number of employees declines in the post adoption period, which is consistent with a lower COGS. We find no evidence, however, that managers significantly reduce depreciation, advertising or R&D expenses. Moreover, it does not appear that managers attempt to manipulate reported earnings by increasing accruals. The obvious implication of this study is that through the adoption of long term performance plans, shareholders can mitigate the agency problem by inducing management to reduce wasteful expenditures on excessively large workforces and inventories. These results suggest that a prominent manifestation of agency conflict within the firm is lack of managerial oversight over the size of the corporate workforce and inventories.

Strategic analysis of operating income: an extension to Horngren, Foster and Datar

Abstract In the 10th edition of their Cost Accounting text, Horngren, Foster and Datar introduce the concept of strategic analysis of operating income by separating a companys operating income into growth, price-recovery, and productivity components. These components are then used to evaluate the success, or lack thereof, of a companys cost-leadership or product differentiation strategies. I extend their analysis of fixed capacity costs in the following manner. First, I suggest that the “long-term view” supported by activity-based costing might be more appropriate for determining the growth component instead of the “short-term view” supported by throughput costing and Goldratt and Cox in The Goal . Next, I introduce a new component called capacity underutilization into their formulation which highlights the impact of (1) changing capacity costs relating to unused capacities, (2) changes in available capacities between the years, and (3) changes in capacities used between the years.

The Determinants of Performance Plan Adoption

Executive compensation schemes are expected to reduce agency costs by aligning the interests of stockholders and managers. We attempt to determine the characteristics of companies that adopt long-term performance plans. Using a matched-pair design, we conduct a multivariate logit analysis that is weighted to take into account the choice-based nature of the sample. Our results suggest that performance plans may have been adopted to complement the inadequate compensation derived from stock options. In addition, we find that performance plans are more likely to be adopted by companies who have smaller investment opportunity sets and have older managers who are underinvesting in R&D expenditures.

Relative Strategic Variance Analysis: The Case of American Airlines

A Strategic Variance Analysis (SVA) is a management tool used to establish reasons for differences in a firm’s operating income between two time periods – reasons that may not always be apparent from the financial statements. SVA allows management to determine, in the form of performance variances, changes in operating income resulting from changes in sales volume, sales prices, unit costs per unit of activity, productivity and capacity utilization. An SVA of American Airlines’ 2009 results, as compared to its 2008 results, reveals improvements in operating income of

Market share and market size variances in a multi-product environment: An evaluation of competing formulations

891 million. Specifically, the results reveal that American Airlines reduced its sales volume, reduced its ticket prices, reduced its unit costs per unit of activity, improved its productivity and reduced its level of capacity underutilization. While this is important information for American Airlines’ management to evaluate the impact of its strategic initiatives and gauge progress in meeting performance goals, it lacks a competitive perspective. Relative Strategy Variance Analysis (RSVA) provides such a competitive perspective. It allows firms to examine how the specific performance variances determined in an SVA compare with those of its industry by allowing firms to identify whether these performance variances are driven by industry effects or firm-specific effects. RSVA is most useful in situations where firms are altering their competitive strategy positions (launching new products or services, changing pricing, reducing input costs, altering production to improve efficiency) in an environment where competitors are making similar strategic changes. Individual competitors can use RSVA to understand how their performance improvements compare with those of the general industry. An RSVA of American Airlines reveals that the 2009 improvement of

The absorption vs. direct costing debate: a compromise solution

891 million actually represents a favorable industry effect of

Capacity Costs with Time-Based and Use-Based Asset Value Attrition

1.2 billion, i.e., American Airlines’ 2009 improvement would have been

Using capacity utilization to adjust ROI performance drivers

1.2 billion if it had matched industry performance. Its firm-specific effect was an unfavorable

Evaluating the “keep-or-drop” decision

296 million, i.e., American Airlines 2009 operating income, after considering industry effects, actually declined by