The Real Effects of Financial Reporting on Pay and Incentives

39 Pages Posted: 6 May 2020 Last revised: 26 May 2020

See all articles by John E. Core

John E. Core

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: April 10, 2020

Abstract

This paper discusses two real effects of financial reporting on pay and incentives:

(1) Better earnings leads to better incentives, and

(2) If pay is mis-measured, pay can be mis-used.

The first real effect follows from the fact that incentives are often based on earnings, and the effectiveness of earnings-based incentives is positively related to the quality of earnings. Greater use of earnings in incentives provides better incentives at a lower cost. The second real effect has to do with how well the accounting system measures the expense of various pay components. Complex calculations are required to value complex pay components such as options, post-employment benefits, and performance-vested equity, and these calculations have historically not been done correctly. The incorrect accounting leads to these pay components being mis-used. I conclude by discussing how accounting and disclosure of pay and incentives can be improved.

Keywords: Pay, Incentives, Real Effects, Earnings Quality, Accounting Quality

Suggested Citation

Core, John E., The Real Effects of Financial Reporting on Pay and Incentives (April 10, 2020). Available at SSRN: https://ssrn.com/abstract=3568502 or http://dx.doi.org/10.2139/ssrn.3568502

John E. Core (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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E62-416
Cambridge, MA 02138
United States

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