Agents often inflate measured performance by distorting operating decisions (e.g., real earnings management) and/or reporting decisions (e.g., accruals management). Across four studies, we find that public judgments of distortion's acceptability largely reflect assessments of how harmful and norm-violating the distortion is. Judgments of operating distortion primarily reflect assessments of harm, whereas judgments of reporting distortion primarily reflect assessments of norm violation. These results are consistent with the Theory of Dyadic Morality (Gray, Waytz, and Young 2012; Schein and Gray 2018). We also find that those who perceive an accounting system as more unfairly withholding an agent's bonus assess distortion (especially reporting distortion) to be less norm-violating. Those who perceive the performance measure as less appropriate for capturing the value of performance to stakeholders assess distortion (especially operating distortion) to be more harmful. Assessments of distortions' harm and norm violation explain a substantial portion of the variation in acceptability judgments.

ABSTRACTMany firms use relative stock performance to evaluate and incentivize their CEOs their. We document that such firms routinely disclose information that harms their peers' stock prices, and sometimes explicitly mention the harmed peers, by name, in these disclosures. Consistent with deliberate sabotage, peer‐harming disclosures appear to be aimed at peers whose stock price depressions are most likely to benefit the disclosing firms' CEOs. The pricing effect of these disclosures does not reverse, suggesting that the disclosures contain legitimate information regarding peers' prospects. In sum, our results suggest that relative performance evaluation in CEO pay motivates CEOs to internalize the externalities of their disclosures, and strategically disclose information that harms peers' stock prices, in order to improve their firms' relative standing within their peer group.

ABSTRACT The negative effects of common ownership on competition have received significant attention, but many proposed mechanisms for institutional investor influence seem implausible. We develop and test an analytical model of optimal compensation in an oligopoly with common ownership, focusing on revenue-based pay as a plausible channel through which institutional investors might influence competition. Our model implies a negative effect of common ownership on firms’ use of revenue-based pay. Using both associative analyses and an event study difference-in-differences design based on plausibly exogenous institutional mergers, we find no evidence of a negative relation between common ownership and the use of revenue-based pay, except in an economically small subsample of extremely concentrated owners. Results involving relative performance incentives are similar. Collectively, our results provide no support for the notion that cross-owning blockholders in general influence compensation contracts in order to soften executives’ incentives to compete aggressively. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: D43; G30; L13; M12; M40; M52.

We examine the relation between relative performance evaluation (“RPE”) in executive pay plans and labor talent poaching of rank-and-file employees. Using resume data, we document that RPE-using firms hire significantly more labor talent away from their RPE peers than from their other industry rivals. This effect is most pronounced among hard-to-replace employees (i.e. higher skilled and longer tenured employees). Collectively, the evidence suggests that firms poach hard-to-replace labor talent away from their RPE peers in order to harm the peers’ performance outcomes, thereby improving the focal firm’s relative performance (and thus the CEO’s compensation).

We analyze voluntary disclosure practices in the presence of a leak risk. In a standard model of voluntary disclosure, managers are less forthcoming when negative information may be leaked by external sources. However, if managers prefer to be the bearer of their firm's bad news, potential leaks motivate managers to disclose negative information, preemptively. Empirically, we document that when the probability of a leak is higher, firms offer earnings guidance more frequently and generate systematically lower returns on their voluntary disclosure dates, but subsequently perform better at the time of the potential leak. Poor disclosure-day returns are explained by potential imminent leaks, but not leaks that may have recently occurred. These patterns are consistent with our model of leak preemption; when facing a potential leak, managers become more forthcoming in order to preempt the leaks.

Using a high-granularity dataset containing retail prices for ~300,000 products spanning ~1,000 narrowly-defined product categories, I examine how product prices relate to the performance metrics used in CEO pay plans. Firms with large market shares reduce their product prices when the CEO is compensated on the basis of: (1) accounting-based relative performance evaluation (“RPE”) and/or (2) performance metrics that shield the CEO from expenses (e.g., sales or EBITDA). Price reductions occur sharply around the adoption of accounting-based RPE, but occur slowly around the adoption of sales-based pay. Price reductions with accounting-based RPE are most pronounced in product categories where firms compete directly against their RPE peers. Collectively, this evidence is consistent with a large body of theoretical work which shows that RPE and cost shielding encourage competitive aggression. The high granularity of the dataset allows for a tight empirical design which rules out many non-causal explanations.

We develop an algorithm that mimics the relative performance evaluation (“RPE”) peer selection process used for CEOs’ incentive plans. Our algorithm constructs the portfolio of peer firms that exhibits the highest in-sample stock performance correlation with the focal firm, which we then use as a counterfactual to better understand firms’ actual RPE choices. We find that most firms use RPE in a manner consistent with optimal risk-sharing; firms are more likely to use RPE when a viable peer group is available, and they construct peer groups that are about as effective as possible at shielding CEOs from outcome risk. However, some firms choose not to use RPE even when an effective peer group is available; non-reliance on RPE in these cases appears to be related to competitive sabotage concerns. Other firms choose to use RPE, but benchmark against a peer group that is not effective from a risk-sharing perspective; reliance on RPE in these cases appears to be related to rent-extraction. Collectively, our study improves the understanding of firms’ ex ante ability to construct an effective peer group, and thereby sheds new light on why firms do—and perhaps more importantly, why some firms do not—use relative performance evaluation in their CEOs’ incentive plans.

Most firms covary more positively with downmarkets than upmarkets-a phenomenon I refer to as "risk asymmetry." I predict and find that risk asymmetry is caused, at least in part, by a firm's ability to selectively obfuscate poor performance. Risk asymmetry decreases significantly when firms are required to adhere to the more stringent auditing standards mandated under Section 404 of the Sarbanes-Oxley Act, however this decrease is more muted for firms with weak internal controls. Consistent with my predictions, these patterns are stronger for more market-sensitive firms and weaker for firms that include relative performance evaluation in their CEOs' pay packages. Taken together with prior literature (which documents that risk asymmetry is priced), my results suggest that a firm can lower its cost of capital by credibly reducing its ability to obfuscate value-relevant information.

In three studies totaling almost 5000 subjects, we present respondents with scenarios in which employees manage performance measures by distorting how they report performance or how they operate their organizations. We measure respondents’ judgments about the scenarios and their broader moral values, and interpret statistical associations in light of Moral Foundations Theory (Graham, Nosek, et al 2011) to draw inferences on how respondents view the ‘moral terrain’ of morally-relevant features depicted by the scenarios we present. In our business, public school and hospital settings, we conclude that respondents see reporting distortion as a more appropriate remedy than operating distortion to inequity, and see operational distortions as improving underlying performance more effectively when measures capture true performance more accurately. In our public school and hospital settings, we also conclude that respondents see the organization, (i.e. school or hospital), rather than outside stakeholders, (i.e. students or patients), as representing the in-group to which managers owe loyalty. Respondents also see a sacred element both in reporting and in supporting a school or hospital.

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A 2006 rule change in the United States mandated that publicly traded firms provide more detailed disclosures about executives’ compensation plans. In response to the new disclosure requirements, Cournot firms with large market shares add revenue-based pay to their CEOs’ pay packages. This change in pay practices coincides with a shift towards more aggressive product market equilibria, characterized by greater production expenditures and lower margins. Jointly, these patterns are consistent with predictions from the theory of “strategic delegation,” and suggest that the new disclosure requirements enhanced the viability of committing through executive incentives. After adopting the new disclosure requirements, many firms appear to restructure their executives’ pay packages as strategic devices designed to make rivals curtail their competitive actions.

Many firms use relative stock performance to evaluate and incentivize their CEOs. We provide evidence that such firms routinely disclose information that harms peers’ stock prices. Consistent with deliberate and strategic sabotage, peerharming disclosures appear targeted at the peers whose stock price performances are more likely to have an impact on the CEO’s compensation, especially towards the end of a fiscal year. This strategy also carries a cost for the disclosing firms; these disclosures appear to be more informative about the peers, and less informative about the disclosing firms, having larger effects on the peers’ trading volumes and smaller effects on the disclosing firms’ trading volumes. That is, firms seem to sacrifice some of the capital market benefits typically associated with voluntary disclosure in order to boost their relative standing amongst their RPE peers through sabotage. JEL Classifications : M41

Executive bonus plans often incorporate performance measures that exclude particular costs—a practice we refer to as “cost shielding.” We predict that boards use cost shielding to mitigate underinvestment and insulate new managers from the costs of prior executives’ decisions. We find evidence that boards use cost shielding to deter underinvestment in intangibles and encourage managers to take advantage of growth opportunities. We also find that cost shielding tends to be elevated for newly-hired executives, and decreases over tenure. Collectively, our results suggest that boards deliberately choose performance metrics that alleviate agency conflicts.

We examine whether the potential for costly sabotage is a deterrent to firms' use of relative performance evaluation (“RPE”) in CEO pay plans. We exploit illegal cartel membership as a source of variation in the potential for costly sabotage and document that firms are more likely to use RPE if they are currently cartel members. Moreover, firms frequently drop RPE from their CEOs’ pay plans immediately after their cartels are detected, dissolved and punished. We further provide suggestive evidence that the potential for costly sabotage explains these patterns; cartel membership severs the empirical association between RPE and competitive aggression.

We use firms’ unrestated financial statements to estimate the rate at which a dollar of working capital converts into future cash. We show analytically that higher conversion rates correspond to working capital accounts with fewer errors. For the median firm in our sample, working capital converts into cash flow at a rate of 94 cents on the dollar, but there is considerable variation. For firms with higher conversion rates, working capital has a stronger association with contemporaneous stock returns. Firms with lower conversion rates are significantly more likely to receive an AAER, restate earnings, or report an internal control weakness. Conversion rates increase after firms comply with Sarbanes-Oxley and are lower when firms barely avoid reporting a loss. JEL classifications : M41, M42.

A 2006 rule change mandated that publicly traded companies provide more detailed disclosures about executives’ compensation plans. In response to the new disclosure requirements, Cournot firms with large market shares add revenue-based pay to their CEOs’ pay packages. This change in pay practices coincides with a shift towards more aggressive product market equilibria, characterized by greater production expenditures and lower margins. Jointly, these patterns are consistent with predictions from the theory of “strategic delegation,” and suggest that the new disclosure requirements enhanced the viability of committing through executive incentives. After adopting the new disclosure requirements, many firms appear to restructure their executives’ pay packages as strategic devices designed to make rivals curtail their competitive actions.

Using plausibly exogenous variation in Chinese imports, we provide evidence that firms strategically announce capacity expansions when facing entry threats. We first construct and validate a novel text-based measure of voluntary disclosure that reflects firms' explicit forward-looking statements about capacity expansion plans. We then show that firms respond to heightened entry threats by announcing capacity expansions. Consistent with our predictions, larger firms are more likely to respond in this fashion, while more opaque firms are less likely to respond in this fashion. Our results cannot be explained by an overall increase in transparency/disclosure; we observe no increase overall disclosure. Thus, our results are unlikely to be driven by investors' demand for information, but rather firms' strategic choices to supply information in order to protect their product markets. Capacity expansion announcements appear to be effective at deterring entry.

We estimate the firm-level rate at which working capital accruals convert into future cash flows. These conversion rates determine the expected cash value of a dollar of working capital accruals. For firms whose accrual innovations reverse within one year, we find that, on average, a one dollar innovation to accruals translates into 95 cents of cash flow in the subsequent fiscal year. We find that the relation between working capital accruals and annual returns increases with the rate at which accrual innovations convert to cash flows, as does the relation between accruals and annual bonus pay to the CEO. Moreover, when accrual innovations convert more quickly and completely to cash flows, firms are less likely to receive an Accounting and Auditing Enforcement Release (AAER) from the SEC.

The paper examines whether international regulatory harmonization increases cross-border labor migration. To study this question, we analyze European Union (EU) initiatives that harmonized accounting and auditing standards. Regulatory harmonization should reduce economic mobility barriers, essentially making it easier for accounting professionals to move across countries. Our research design compares the cross-border migration of accounting professionals relative to tightly-matched other professionals before and after regulatory harmonization. We find that international labor migration in the accounting profession increases significantly relative to other professions. We provide evidence that this effect is due to harmonization, rather than increases in the demand for accounting services during the implementation of the rule changes. The findings illustrate that diversity in rules constitutes an economic barrier to cross-border labor mobility and, more specifically, that accounting harmonization can have a meaningful effect on cross-border migration.