THE EFFECT OF BONUS SCHEMES ON ACCOUNTING DECISIONS updated Accounting Theory AT1
THE EFFECT OF BONUS SCHEMES ON ACCOUNTING DECISIONS
A study by Paul M. Healy (1984)
PRESENTERS
Bonuses have been a type of compensation for corporate executives for decades. In fact, stock options, stock appreciation rights, and performance plans are other forms of remuneration in today’s world for executives. In 1984, a man by the name of Paul M. Healy conducted a research paper on the association between managers’ accrual and accounting procedures and income reporting. Healy was testing the hypothesis of earlier works by namely Watts (1977) and Watts and Zimmerman (19787) that managers have an incentive to adjust earnings through accruals to increase the size of their bonuses as well as change accounting policies following changes in bonus plan structure.
These earlier tests presented conflicting results. First, the concepts of earnings were not defined. Secondly, these studies ignored the fact that it is a possibility for managers to select income-decreasing accruals such as deferring revenues in order to realize a “bigger” bonus next year a concept known as ‘taking a bath’. For example, if earnings are so low that target earnings will not be met, then the manager incentives to reduce earnings even further in the current year.
What did Healy do differently?
This paper is limited to firms who only have bonuses structures based on income. and not Bbonuses and performance plans structures were not included. The sample data is 94 firms and 2 types of tests were performed. (i) accrual tests and (ii) changes in accounting procedures. Accruals in the paper are defined as the difference between cash flow from operations and reported earnings.
The formulas
The formula for calculating a bonus plan with no upper limit can be defined by: Bt = pt {max (Et – Lt),0} where Et is reported earnings in time t Lt is the earnings target or lower bound Pt is the maximum percentage allocated to the bonus pool
The formula for
A study by Paul M. Healy (1984)
PRESENTERS
Bonuses have been a type of compensation for corporate executives for decades. In fact, stock options, stock appreciation rights, and performance plans are other forms of remuneration in today’s world for executives. In 1984, a man by the name of Paul M. Healy conducted a research paper on the association between managers’ accrual and accounting procedures and income reporting. Healy was testing the hypothesis of earlier works by namely Watts (1977) and Watts and Zimmerman (19787) that managers have an incentive to adjust earnings through accruals to increase the size of their bonuses as well as change accounting policies following changes in bonus plan structure.
These earlier tests presented conflicting results. First, the concepts of earnings were not defined. Secondly, these studies ignored the fact that it is a possibility for managers to select income-decreasing accruals such as deferring revenues in order to realize a “bigger” bonus next year a concept known as ‘taking a bath’. For example, if earnings are so low that target earnings will not be met, then the manager incentives to reduce earnings even further in the current year.
What did Healy do differently?
This paper is limited to firms who only have bonuses structures based on income. and not Bbonuses and performance plans structures were not included. The sample data is 94 firms and 2 types of tests were performed. (i) accrual tests and (ii) changes in accounting procedures. Accruals in the paper are defined as the difference between cash flow from operations and reported earnings.
The formulas
The formula for calculating a bonus plan with no upper limit can be defined by: Bt = pt {max (Et – Lt),0} where Et is reported earnings in time t Lt is the earnings target or lower bound Pt is the maximum percentage allocated to the bonus pool
The formula for