Non-Financial Performance Measures in CEO Bonus Contracts: Complement or Substitute for Equity-Based

Equity-Based Compensation and Managerial Behavior

This study examines whether non-financial performance measures (NFPMs) included in CEO bonus contracts (hereafter, bonus contracts) are complementary to the use of equity-based compensation, and whether NFPMs and equity-based compensation jointly explain future firm value. Equity-based compensation (e.g., restricted stocks and stock options) is an example of a deferred performance-based component of compensation intended to induce managers to focus on long-tenn consequences and maximize the firm's long-term value (e.g., Bebchuk & Stole, 1993; Zhou, 2001). Compensation structures that heavily weight equity-based components are expected to motivate managers to focus more on long-term value (Jensen & Murphy, 1990; Murphy, 1985). Nevertheless, a number of studies show that although equity-based compensation is intended to promote a long-term focus, it is likely toaggravate opportunistic managerial behavior, such as aggressive ac-counting practices and reduced capital investment.

recognition that equity-based compensation can motivate managers to take excessive risks. In response, the U.S. House of Representatives passed the Corporate and Financial Institution Compensation Fairness Act of 2009. This law gives shareholders nonbinding advisory votes to approve the compensation of executives, requires independence for compensation committees, and mandates regulatory review and over-sight of financial institutions' incentive compensation plan design.

Meanwhile, the Securities and Exchange Commission (SEC) has com-mitted to establishing proxy disclosure rules to continuously increase the transparency of compensation decisions (e.g., it amended its ex-ecutive compensation disclosure requirements; SEC 2009). Our study extends this line of research and contributes to these ongoing debates by focusing on how the performance measures used in a firm's bonus contracts can interact with equity-based compensation to enhance the firm's long-term value. In a performance evaluation system, both accounting-based and market-based financial measures can be noisy and short-term or-iented—and thus imperfectly informative about managerial perfor-mance (e.g., Bushman, Indjejikian, & Smith, 1996; Ittner, Larcker, & Rajan, 1997; Said, HassabElnaby, & Wier, 2003; Schiehll & Bellavance, 2009). In particular, managers may be more concerned about the market's short-term valuation if their career concerns and compensa-tion packages are tied to short-term performance (Bebchuk & Stole,

recognition that equity-based compensation can motivate managers to take excessive risks. In response, the U.S. House of Representatives passed the Corporate and Financial Institution Compensation Fairness Act of 2009. This law gives shareholders nonbinding advisory votes to approve the compensation of executives, requires independence for compensation committees, and mandates regulatory review and over-sight of financial institutions' incentive compensation plan design. Meanwhile, the Securities and Exchange Commission (SEC) has com-mitted to establishing proxy disclosure rules to continuously increase the transparency of compensation decisions (e.g., it amended its ex-ecutive compensation disclosure requirements; SEC 2009).

Our study extends this line of research and contributes to these ongoing debates by focusing on how the performance measures used in a firm's bonus contracts can interact with equity-based compensation to enhance the firm's long-term value. In a performance evaluation system, both accounting-based and market-based financial measures can be noisy and short-term or-iented—and thus imperfectly informative about managerial perfor-mance (e.g., Bushman, Indjejikian, & Smith, 1996; Ittncr, Larckcr, & Rajan, 1997; Said, HassabElnaby, & Wier, 2003; Schichll & Bellavancc, 2009). In particular, managers may be more concerned about the market's short-term valuation if their career concerns and compensa-tion packages are tied to short-term performance (Bcbchuk & Stoles