Ex Post Settling Up in Cash Compensation: New Evidence

Abstract

ABSTRACT This paper provides new evidence on whether and how boards solve costly ex post settling up to recover CEO cash compensation for unrealized gains that fail to materialize. Our analyses are motivated by the likely expanding role for ex post settling up as the risk of compensating executives for unrealized gains that may never materialize increases in a more intangibles‐based economy, as well as by the conflicting evidence of prior research. We provide evidence consistent with ex post settling up by (i) using alternative truncation methods to derive observations most likely to fall within the theoretically motivated incentive zone; (ii) replicating and reconciling the conflicting results of prior research that supports (Leone et al. 2006) and fails to support (Shaw and Zhang 2010) ex post settling up; (iii) using Incentive Lab data with contract‐specific information, allowing strong identification of observations in the incentive zone; and (iv) documenting predictable cross‐sectional variation, with ex post settling up being more pronounced for firms with stronger corporate governance, less conservative accounting earnings, and a larger proportion of total pay in the form of cash compensation. Overall, we conclude that evidence is strong in support of the ex post settling up hypothesis.

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