CEO pay and non-GAAP reporting are linked, study shows
By Jenny Ruth
Dec. 10 (BusinessDesk) - The more highly paid the chief executives of publicly listed companies, the more likely they
are to use figures that don’t conform to generally accepted accounting principles, according to a University of Otago
study.
Not only is the use of such non-GAAP figures increasing, but managers are more likely to use them when they miss their
GAAP earnings benchmarks, the study found.
“Firms experiencing a decrease in earnings demonstrate a stronger association between CEO cash compensation and the
likelihood of non-GAAP disclosure,” says one of the three authors, Dr Dinithi Ranasinghe.
“This suggests some managers may be disclosing these measures with opportunistic intentions,” Dr Ranasinghe says.
The other two authors are Dr Helen Roberts and Professor David Lont, head of the university’s department of accountancy
and finance.
All the companies in the study were NZX-listed. Between 50 and 60 company reports were examined each year between 2004
and 2013 for a total of 622 in total. The financial sector was excluded.
The study found that the proportion of loss-making firms using non-GAAP figures rose from 33 percent in 2004 to 70
percent in 2013. However, in 2006 only 13 percent of loss-making firms used non-GAAP numbers.
The proportion of profitable firms reporting an earnings increase using non-GAAP figures varied considerably from 53
percent in 2004 to as few as 28 percent in 2006 and as many as 65 percent in 2012.
“Put simply, when targets are missed, it can be argued that managers are using non-standard reporting methods to help
protect their compensation or detract from poor GAAP-based earnings results,” Dr Ranasinghe says.
Professor Lont says shareholders need to be wary of the use of non-GAAP numbers.
“A company may argue that their use of non-GAAP measures is to explain their performance better. But if CEOs are
highlighting selective profit metrics instead of GAAP measures, due to a desire to improve their compensation or
disguise poorer performance – essentially painting the picture they want investors to see whilst detracting from
potential negative performance shown in GAAP measures – then this should raise alarm bells,” the professor says.
That may mean more regulation of New Zealand’s reporting of non-GAAP profit figures might be needed, he says.
On the other hand, the study found no evidence of a relationship between equity-based incentives and disclosures,
“despite their inclusion in the compensation contract reducing moral hazard.”
In other words, equity-based incentives tend to better align a chief executive’s interests with that of shareholders.
“The power of the equity incentives model may be weaker because of the opaque nature of equity compensation disclosure
in New Zealand,” the study says.
The authors suggest their findings can inform regulatory guidance in smaller markets with similar institutional
structures to New Zealand.
“In particular, the results regarding opportunistic intentions related to CEO cash compensation indicate that regulators
should mandate reconciliation provision requirements and reasons for releasing non-GAAP measures,” the study says.
It notes that GAAP accounting earnings-based performance measures often fail to capture managers’ value-increasing
actions, encouraging the use of alternative performance measures such as non-financial measures, revenue targets and
cost reduction goals in compensation contracts.
(BusinessDesk)