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CFO Fiduciary Responsibilities and Annual Bonus Incentives

Authors


  • We acknowledge the support of the American Institute of Certified Public Accountants in this research project. We also wish to thank Merle Erickson (editor) and an anonymous reviewer for suggestions on how to improve the paper as well as numerous colleagues who provided us with feedback on the survey instrument used to collect data. The paper has benefited from comments of workshop participants at the University of Chicago Graduate School of Business, the Wharton School of the University of Pennsylvania, the University of Michigan Harvey Kapnick Accounting Conference, Duke-UNC Accounting Fall Camp, the Rotman School of Management at the University of Toronto, the 2008 AAA MAS meeting, and the 2008 AAA annual meeting.

ABSTRACT

We examine how firms design bonus plans of their CFOs. CFOs participate in decision making much like other executives, but they also have significant fiduciary responsibilities for reporting firms’ financial results. Responsibility for financial reporting raises the question of whether it is appropriate to pay CFOs annual bonuses contingent on self-reported financial performance. In this paper, we provide a framework that characterizes CFO bonuses as a tradeoff between CFOs’ decision-making responsibilities and their fiduciary duties over financial reporting. This framework yields a number of implications that we examine empirically using a proprietary survey of CFO compensation practices of public and private firms. Our main finding shows that from 2003 to 2007 public entities (relative to private entities) reduced the percentage of CFO bonuses contingent on financial performance. We interpret this result as evidence that firms mitigate misreporting practices in part by deemphasizing CFO incentive compensation.

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