The Choice of Different Types of Subjectivity in CEO Annual Bonus Contracts
The Accounting Review · 2011 · Volume 86 · Issue 6
Abstract
In assessing the performance of the CEO, subjectivity by the board of directors is often present in one form or another. We specifically focus on: (1) theex anteoption toex postoverride a formula-based contract (“discretionary bonus”), and (2) theex anteabsence of any formula in a contract (“subjective weights”). We argue that the two types of deviations are driven by different contracting problems, which relate to whether post-contract information does or does not affect the agent's optimal action choice. We refer to these different contracting problems as problems of risk and problems of noncongruity, respectively, and hypothesize that discretionary bonuses are used for risk-reduction purposes, while subjective weights on different performance dimensions are used for congruity-improvement purposes. Our results are consistent with our expectations, showing that the use of the different types of subjectivity is consistent with optimal contracting considerations. Data Availability:All data are publicly available from the sources identified in the text.
Keywords
board discretion, optimal contracting, bonus contracts, corporate governance
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