Management Compensation And Project Life

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Charles I. Harter
T. Harikumar

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Abstract

The goal of this paper is to empirically examine the relation between management compensation and project life.  Prior theoretical research suggests that short-term compensation, in the form of bonus plans, have a tendency to induce managers to invest in projects with short lives. Initially, we develop a model that relates management compensation, earnings announcement and project life defined in terms of duration.  Our testable hypothesis states that a greater weight placed on short-term compensation induces managers to invest in projects with shorter duration and is reflected in a lower earnings response coefficient (ERC) for a concurrent earnings announcement. We empirically examine whether there is a relation between type of managerial compensation and ERC. After controlling for the firm's investment opportunity set and other variables known to affect the ERC, we find strong evidence indicating a negative relation between project life and the fraction of short-term compensation in the total compensation package.  This result provides evidence that managers with greater proportionate earnings-based compensation tend to invest in shorter-term projects.

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