TAILIEUCHUNG - THE EFFECT OF BONUS SCHEMES ON ACCOUNTING DECISIONS*

The various trading and emissions schemes around the world can offer significant benefits of capital allocation for this scarce resource. For the first time carbon will become a real input cost for many businesses and managing the risks and opportunities of that input will become an important business priority. Accounting for carbon emissions will take many companies into entirely new territory for which no specific accounting standard currently exists. Communicating your objectives, policies and results to investors and analysts and explaining how they are reflected in the financial statements could be a significant challenge. This paper offers a guide to. | Journal of Accounting and Economics 7 1985 85-107. North-Holland THE EFFECT OF BONUS SCHEMES ON ACCOUNTING DECISIONS Paul M. HEALY Massachusetts Institute of Technology Cambridge MA 02139 USA Received October 1983 final version received September 1984 Studies examining managerial accounting decisions postulate that executives rewarded by eamings-based bonuses select accounting procedures that increase their compensation. The empirical results of these studies are conflicting. This paper analyzes the format of typical bonus contracts providing a more complete characterization of their accounting incentive effects than earlier studies. The test results suggest that 1 accrual policies of managers are related to income-reporting incentives of their bonus contracts and 2 changes in accounting procedures by managers are associated with adoption or modification of their bonus plan. 1. Introduction Eamings-based bonus schemes are a popular means of rewarding corporate executives. Fox 1980 reports that in 1980 ninety percent of the one thousand largest . manufacturing corporations used a bonus plan based on accounting earnings to remunerate managers. This paper tests the association between managers accrual and accounting procedure decisions and their incomereporting incentives under these plans. Earlier studies testing this relation postulate that executives rewarded by bonus schemes select income-increasing accounting procedures to maximize their bonus Their empirical results are conflicting. These tests however have several problems. First they ignore the earnings definitions of the plans earnings are often defined so that certain accounting decisions do not affect bonuses. For exam- 1 am indebted to Ross Watts for many valuable discussions and for his insightful remarks on this paper. I also wish to thank the remaining members of my . committee Andrew Christie Cliff Smith and Jerry Zimmerman for their helpful comments. The paper has benefited from

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