Accounting Based Pay for Performance

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Accounting Based Pay for Performance

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Title: Accounting Based Pay for Performance
In a corporate governance perspective
Author: Brun Christensen, Philip
Abstract: The focus of the thesis is accounting based performance pay, used in Danish companies. According to agency theory there exist a problem since the agent’s interests is not aligned with the principal’s. It is this problem that bonus contracts are used to solve. Recently there has been an increased debate concerning stock shares and stock options in relation to the financial crisis. The thesis focuses on accounting based bonus contracts in order to assess their ability to align management’s interest with the owner’s interest. The thesis has identified seven bonus criteria that are used to evaluate accounting based bonus contracts. These seven criteria are; congruency, controllability, simplicity, objectivity, low number of accounting issues, cost efficient to develop and timeliness. The most important criterion is the congruency, fulfilling this criterion ensures that company value is created which is in the owner’s interest. These criteria are used to evaluate the three components of a bonus contracts; performance measure, performance standard and pay for performance structure. The recommendation to remuneration boards and shareholders is to use accounting based bonus contracts that include EVA, as the performance measure, an external peer-group, as the performance standard, and a linear pay for performance structure. Furthermore the bonus contract should include a bonus bank where a predetermined share of the bank balance is paid out annually. Thereby ensuring the bonus contract reflects performance over multiple-periods. The bonus bank also facilitates that poor performance can be punished. This symmetry between the upside and downside of the performance-based compensation is recommended by the OECD – Principles on Corporate Governance, as well as the Danish Committee on Corporate Governance. This combination of performance measure, standard and pay-for-performance structure is the one according to theory that especially fulfils the congruence, controllability criteria. The empirical findings do not support the use of the above bonus components. The empirical findings is characterised by using absolute performance measures, which excludes balance sheets items, budget standards that which management are able to influence and pay for performance structure that is of the non-linear type. Evaluating these bonus components with the prior mentioned bonus criteria reveals that this combination of bonus components has a low congruence with value creation, they are however simple, cost efficient, since income statement items are already reported and budgets are usually developed annually.
URI: http://hdl.handle.net/10417/4821
Date: 2015-01-16
Pages: 130 s.
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