ABSTRACT This paper examines the relative weights assigned to three performance measures—stock returns, accounting earnings, and operating cash flows—in determining executive cash compensation. We find that returns receive the highest weight, followed by earnings, while cash flows carry the least weight. We further investigate how discretionary accruals influence the incremental weights placed on these performance measures. Guided by agency theory, we predict and find that as discretionary accruals introduce uncertainty into earnings, the weight on earnings decreases, the weight on returns declines to a lesser extent, and the weight on operating cash flows remains unchanged. Additional cross‐sectional analysis suggests that traditional pay‐for‐performance models may not fully apply to firms in sin industries.
Dai et al. (Thu,) studied this question.