Pirates of the Mediterranean: An Empirical Investigation of Bargaining with Asymmetric Information

Using a large dataset of performance goals employed in executive incentive contracts <br/>we find that a disproportionately large number of firms exceed their goals by a small <br/>margin as compared to the number that fall short of the goal by a similar margin. This <br/>asymmetry is particularly acute for earnings and profit goals, when compensation is <br/>contingent on a single goal and is present for both long-term and short-term goals, when <br/>the pay-for-performance relationship is concave or convex and for grants with cash or <br/>stock payout. Firms that exceed their compensation target by a small margin are more <br/>likely to beat the target the next period and CEOs of firms that miss their targets are <br/>more likely to experience a forced turnover. Firms that just exceed their EPS goals have <br/>higher abnormal accruals and lower Research and Development (R&D) expenditures <br/>and firms that just exceed their profit goals have lower SG&A expenditures. Overall, <br/>our results highlight some of the costs of linking managerial compensation to specific <br/>compensation targets.