Hostname: page-component-848d4c4894-2xdlg Total loading time: 0 Render date: 2024-06-21T07:41:05.038Z Has data issue: false hasContentIssue false
  • English
  • Français

Choosing the Precision of Performance Metrics

Published online by Cambridge University Press:  10 July 2018

Alan D. Crane ,
Andrew Koch  and
Chishen Wei
Get access Rights & Permissions [Opens in a new window]

Abstract

There is a standard trade-off in compensation contracts between the provision of incentives and insurance. We hypothesize that this trade-off influences the precision with which firm performance is measured. We find that firm outcomes are measured less precisely when chance plays a large role in these outcomes. Further, this precision is determined through the choice of shares outstanding. This has several novel implications. Nominal stock prices can remain constant over time, and firms with unpredictable cash flows should have more shares and lower stock price levels, all else equal. We find evidence consistent with these implications.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 53 , Issue 4 , August 2018 , pp. 1911 - 1935
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

1

We thank Brian Akins, Leonce Bargeron, Alex Butler, Travis Chow, Mike Crawley, Kevin Crotty, David De Angelis, Dave Denis, Diane Denis, Steve Dimmock, Mei Feng, Radha Gopalan (the referee), Nicole Thorne Jenkins, Nishad Kapadia, Bin Ke, Jin Li, Paul Malatesta (the editor), Sebastien Michenaud, K. Ramesh, Denis Sosyura, Laura Starks, Shawn Thomas, K. C. John Wei, James Weston, and seminar/conference participants at Carnegie Mellon University, Rice University, Texas Tech University, the University of Pittsburgh, and the 2014 Financial Accounting and Reporting Section (FARS) midyear meetings for helpful discussions and comments. We also thank Kenny Phua for excellent research assistance.

References

Amihud, Y.“Illiquidity and Stock Returns: Cross-Section and Time-Series Effects.” Journal of Financial Markets, 5 (2002), 31–56.Google Scholar
Asquith, P.; Healy, P.; and Palepu, K.. “Earnings and Stock Splits.” Accounting Review, 64 (1989), 387–403.Google Scholar
Baker, H. K., and Gallagher, P. L.. “Management’s View of Stock Splits.” Financial Management, 9 (1980), 73–77.Google Scholar
Baker, M.; Greenwood, R.; and Wurgler, J.. “Catering through Nominal Share Prices.” Journal of Finance, 64 (2009), 2559–2590.Google Scholar
Bennett, B.; Bettis, J. C.; Gopalan, R.; and Milbourn, T.. “Compensation Goals and Firm Performance.” Journal of Financial Economics, 124 (2017), 307–330.Google Scholar
Bird, S.; Loper, E.; and Klein, E.. Natural Language Processing with Python. Sebastopol, CA: O’Reilly Media Inc. (2009).Google Scholar
Brandt, M. W.; Brav, A.; Graham, J. R.; and Kumar, A.. “The Idiosyncratic Volatility Puzzle: Time Trend or Speculative Episodes?” Review of Financial Studies, 23 (2010), 863–899.Google Scholar
Cheng, Y.; Harford, J.; and Zhang, T. T.. “Bonus-Driven Repurchases.” Journal of Financial and Quantitative Analysis, 50 (2015), 447–475.Google Scholar
De Angelis, D., and Grinstein, Y.. “Performance Terms in CEO Compensation Contracts.” Review of Finance, 19 (2015), 619–651.Google Scholar
Dennis, P., and Strickland, D.. “The Effect of Stock Splits on Liquidity and Excess Returns: Evidence from Shareholder Ownership Composition.” Journal of Financial Research, 26 (2003), 355–370.Google Scholar
Derrien, F., and Kecskés, A.. “The Real Effects of Financial Shocks: Evidence from Exogenous Changes in Analyst Coverage.” Journal of Finance, 68 (2013), 1407–1440.Google Scholar
Graham, J. R.; Harvey, C. R.; and Rajgopal, S.. “The Economic Implications of Corporate Financial Reporting.” Journal of Accounting and Economics, 40 (2005), 3–73.Google Scholar
Hölmstrom, B.“Moral Hazard and Observability.” Bell Journal of Economics, 10 (1979), 74–91.Google Scholar
Hong, H., and Kacperczyk, M.. “Competition and Bias.” Quarterly Journal of Economics, 125 (2010), 1683–1725.Google Scholar
Kelly, B., and Ljungqvist, A.. “Testing Asymmetric-Information Asset Pricing Models.” Review of Financial Studies, 25 (2012), 1366–1413.Google Scholar
Lakonishok, J., and Lev, B.. “Stock Splits and Stock Dividends: Why, Who, and When.” Journal of Finance, 42 (1987), 913–932.Google Scholar
Rountree, B.; Weston, J. P.; and Allayannis, G.. “Do Investors Value Smooth Performance?” Journal of Financial Economics, 90 (2008), 237–251.Google Scholar
Stock, J. H.; Wright, J. H.; and Yogo, M.. “A Survey of Weak Instruments and Weak Identification in Generalized Method of Moments.” Journal of Business and Economic Statistics, 20 (2002), 518–529.Google Scholar
Weld, W. C.; Michaely, R.; Thaler, R. H.; and Benartzi, S.. “The Nominal Share Price Puzzle.” Journal of Economic Perspectives, 23 (2009), 121–142.Google Scholar