Compensation committees’ treatment of Earnings Components in CEOs’ Terminal years
In an attempt to analyze the relationship between changes in cash compensation and changes in earning components, a group of researchers has jointly uncovered the relationship. It has been evident that toward the end of a CEO’s term, the firm exhibits a lot of variations in its earning components. This is because of numerous attempts by the very CEO’s to manipulate the figures. An outgoing CEO can attempt to inflate current income to augment earnings based compensations. The study, therefore, puts in the light that increased discretionary spending by the CEOs in their late career time has income increasing effect and should be discouraged. The study also finds out that investment activities should be planned and implemented by CEO’s early in their career in order to effectively and with undivided attention, factor in the shareholders’ interests of wealth maximization. As unwise as it might not seem, later career investments by CEOs might not be in the shareholders interest. This argument by Casamatta & Guembel (2010), holds grounds. It is true that an exiting CEO has no shareholders interest in mind when investing in his late career. The act could cause long-term negative effects on the earning of a firm. Another cause of a change in the cash component is the difference between the continuing and exiting CEO. An exiting CEO could attempt to lower investments to reduce assets for his/her successor in order for him/her to be seen like he/she was the best fit for the job and also that he/she performed exemplary (Shleifer & Vishny, 1989).
This act could inflate the short-term earnings. The discussed are some of the ways in which CEOs attempt to change earning components by manipulating expenditures. It is evident that in terminal years, CEO’s increase incentives to maneuver earnings to improve earning based compensation. The committee intervenes to mitigate the situation by setting remuneration limits for the CEO’s during terminal years. They also should disallow the discretionary expenditure by CEOs in their later career (Shleifer & Vishny, 1989). From the research done, I will be in order to say that compensation changes and discretionary expenditures by exiting CEOs has direct relationship to changes in earning of a firm as contends (Casamatta & Guembel, 2010).
The use and market consequence of earnings management and expectation management
The management, in several occasions attempts to stir up market performance by managing earnings, managing expectation or both. These attempts are to provoke a market response that will determine whether the target earnings are met or beaten. It is indicated that independent or joint use of the two tools, based on the constraint of use the manager is subjected to, will have varying impacts on the market performance. Brown & Pinello (2007), contend that firms rely on expectation management because it is cheaper compared to earnings management. Earnings management is more expensive during the fourth quarter due to costs related to preparation of financial reports. Every fourth quarter is a critical time for all firms because financial period will be approaching its end and the shareholders and other stakeholders will demand explicit financial statements. The preparation process of these statements is expensive. The expenses will reduce the earnings and could reduce the value below the targeted earning. From this rises the constraint on using earning management to beat the market during the fourth quarter (Brown & Pinello, 2007).
From the study conducted, Brown & Pinello (2007), suggest that it is appropriate that expectation management be implemented, during the fourth quarter, to avoid costs and to achieve the targeted earning. The two tools can only be used as complements, when there are low costs associated with earnings management. As a result, it is suitable for use in interim financial periods. I can soundly conclude that the argument put forth by Brown & Pinello (2007), is sensible and practical enough to facilitate the beating-target or meeting-target goal of a firm. This is the heartbeat for each firm and it is therefore paramount to establish the above mentioned strategies in order for the firm to undergo a transition without any hitches that could derail the fundamental functions of the firm. The staff is also keen on checking how the transition occurs in order to embrace the unexpected future.
Brown, L., & A. S. Pinello. (2007). To what extent does the financial reporting process curb earningssurprise games? Journal of Accounting Research 45 (5): 947–981.
Shleifer, A., & R. W. Vishny. (1989). “Management entrenchment: The case of manager-specific investments”. Journal of Financial Economics 25 (1): 123–139.
Casamatta, C., & A. Guembel. (2010). “Managerial legacies, entrenchment, and strategic inertia”. Journal ofFinance 65 (6): 2403–2436.