Bonuses and Non-Public Information in Publicly Traded Firms

Abstract

Recent research in accounting explores how firms use “individual” or “non-financial” measures of performance in executive compensation contracts. We model a firm that conditions bonus payments to executives on information that is not available to those outside the firm. This raises two issues. First, market participants may use the magnitude of such payments to infer the non-public information. Second, because information that is non-public is, by extension, non-verifiable, the firm cannot write explicit contracts based on it. Combining the relational incentive contracts and financial signaling literatures, we examine equilibria of a signaling game in which bonus payments from a firm to a manager convey non-public information regarding the firm’s future cash flows. Our main result is that increases in corporate myopia can, under some conditions, lead to increased profits. This finding is contrary to that typically found in financial signaling models.