Deferred compensation, managerial retirement, and the stewardship perspective of financial accounting

Abstract

Deferred compensation is often proposed as an instrument to prevent managerial myopia. However, empirical studies show that its practical use is limited when it comes to managerial retirement. We study the optimal design of accounting-based deferred compensation for retiring managers. While deferred compensation is useful in establishing long-term incentives, it causes contracting frictions in subsequent periods. Deferred bonuses of retiring managers imply inefficiently weak incentives for incoming managers. This down-scaling effect renders deferred compensation less useful in providing long-term incentives. We also find that the down-scaling effect has implications for the desirability of accounting timeliness—that is, the timely recognition of future cash flows in current accounting earnings—from a stewardship perspective. If managers' long-term actions are sufficiently important, higher timeliness can cause more myopic managerial incentives.