ABSTRACT Bonus banks are multiyear performance plans for deferring bonus payments and enhancing pay‐for‐performance by facilitating downward corrections of bonuses. These compensation schemes have become widely accepted among practitioners and regulators in recent years with the aim to reduce managerial short‐termism. This paper examines the incentive properties of bonus bank schemes based on performance measures as proposed in the literature. To attain efficient investment decisions, such a scheme depends on managers' reports about value creation, but managers have incentives to misreport. We study how the bonus bank can be used to elicit truthful reporting and hence efficient investment in multiyear settings. For situations in which equity market values are not applicable, for example, when managers have private information, we find that an internal market for the bonus bank between the leaving manager and the successor can induce truthful reporting under restrictive conditions only. In particular, negotiations under asymmetric information require the successor to have significantly superior capabilities to compensate for the uncertainty inherent in valuing the bonus bank.
Schultze et al. (Tue,) studied this question.
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