Journal of Accounting and Economics 25 (1998) 169—193

Accounting earnings and executive compensation:

The role of earnings persistence
William R. Baber!!*, Sok-Hyon Kang", Krishna R. Kumar!
! School of Business and Public Management, The George Washington University, NW, Washington,
DC 20052, USA
" School of Management, Yale University, New Haven, CT 06520, USA

Received 1 June 1997; received in revised form 1 July 1998

Abstract

A cross-sectional analysis of cash compensation paid to CEOs of 713 US firms

reveals that the sensitivity of compensation to earnings varies directly with earnings
persistence. Additional analysis indicates that this sensitivity is greater for cases where
executives are approaching retirement. Such evidence suggests the use of earnings
persistence to counterbalance adverse consequences of earnings-based contracting with
managers who face finite decision horizons. ! 1998 Elsevier Science B.V. All rights
reserved.

JEL classification: J33; L2; M4

Keywords: Earnings persistence; Executive compensation; Horizon problem

1. Introduction

Contemporary economic theory, which portrays the firm as a series of

contractual relations among stakeholders, establishes a significant role for
accounting performance measures when such measures are incrementally in-
formative with respect to management’s actions or when their use encourages
efficient risk-sharing between contracting parties (Gjesdal, 1981; Holmstrom,
1979; Lambert and Larcker, 1987; Banker and Datar, 1989; Sloan, 1993).

* Corresponding author. Tel.: 202/994 5089; fax: 202/994 5164; e-mail: baber@gwu.edu.

0165-4101/98/$ — see front matter ! 1998 Elsevier Science B.V. All rights reserved.
PII: S 0 1 6 5 - 4 1 0 1 ( 9 8 ) 0 0 0 2 1 - 4
170 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193

This role for accounting is supported by evidence of strong contempor-

aneous correlations between accounting earnings and executive compensation
(e.g., Lambert and Larcker, 1987; Jensen and Murphy, 1990; Baber et al.,
1996).
Despite this considerable theoretical and empirical justification, performance
evaluations based on accounting earnings continue to be criticized for encourag-
ing actions that sacrifice long-term profitability for short-term profit gains
(Smith and Watts, 1982; Dechow and Sloan, 1991; Kaplan and Atkinson, 1998).
This drawback, designated the ‘horizon problem’, occurs when the decision-
maker’s anticipated tenure with the firm is shorter than the firm’s optimal
investment horizon (Smith and Watts, 1982; Johnson, 1987; Dechow and Sloan,
1991; Ittner et al., 1997). Prior studies advocate reliance on long-term perfor-
mance measures, deferred or stock-based compensation, or intra-firm monitor-
ing to extend management’s decision horizon (Lewellen et al., 1987; Tehranian et
al., 1987; Dechow and Sloan, 1991). Such mechanisms can temper the horizon
problem, yet current earnings cannot easily be dismissed as a less preferred basis
for contracting. In particular, both theory and empirical evidence support the
premise that earnings are incrementally useful over stock returns and other
measures for contracting purposes (Holmstrom, 1979; Lambert and Larcker,
1987; Jensen and Murphy, 1990; Sloan, 1993; Baber et al., 1996). Thus, de-
emphasizing current earnings can compromise efficient contracting.
Recent studies suggest that compensation committees adjust earnings-based
performance measures when doing so improves incentive arrangements (Clinch
and Magliolo, 1993; Dechow et al., 1994; Gaver and Gaver, 1998). In this study,
we present evidence that compensation committees consider not only the
current-period earnings innovations but also their persistence into the future
when rewarding managers based on earnings." Using a cross-section of 1992
and 1993 compensation paid to CEOs of 713 US corporations, we find that the
strength of pay-for-performance relations between CEO salary and bonuses and
accounting performance increases with measures of earnings persistence. The
notion that more persistent earnings innovations are assigned greater value in
securities markets is now well documented (Kormendi and Lipe, 1987; Collins
and Kothari, 1989; Ali and Zarowin, 1992a); however, whether and why com-
pensation committees adjust for earnings persistence in executive compensation
contracts are heretofore uninvestigated.
The finding that greater weight is assigned to persistent earnings innovations
appears to be consistent with compensation committees’ efforts to mitigate the

" Other studies that examine whether compensation committees make informed adjustments on
reported earnings include Abdel-Khalik (1985), Healy et al. (1987), Holthausen et al. (1995) and
Natarajan (1996).
 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193 171

horizon problem. Recall that the horizon problem derives from managers’
preferences for lower-NPV projects yielding higher current-period accounting
earnings over higher-NPV projects yielding lower current earnings.
Arrangements that reward earnings persistence encourage managers to look
beyond the current-period earnings and thus extend managers’ decision hor-
izons, without sacrificing the use of earnings as a contracting vehicle. Additional
analysis indicates that relative weights assigned to persistence are greater for
CEOs who are approaching retirement. Such individuals face relatively short
decision horizons, and therefore, this evidence supports an interpretation that
persistent earnings innovations are assigned greater weight to attenuate the
horizon problem.
The executive compensation literature also suggests different roles for current
cash salary and bonus compensation components than for deferred, typically
equity-based, components (Bizjak et al., 1993; Yermack, 1995). Thus, although
our primary focus is to ascertain the extent that earnings persistence is related to
executive compensation, an ancillary issue is whether persistence manifests
differentially for alternative compensation vehicles. Deferred performance-based
components, such as stock options and restricted stock which address long-term
consequences of managers’ actions, are based primarily on security returns.
Equity values impound the consequences of earnings persistence, and therefore,
conditioning equity-based components on earnings persistence can be redund-
ant. Our evidence is consistent with this reasoning. In particular, we find
positive associations between earnings persistence and weights assigned to
current-period earnings innovations for cash salary and bonus components, but
not for deferred equity-based compensation components such as stock options
or restricted stock.
Finally, prior studies report statistically significant correlations between the
properties of earnings time series and firm-specific characteristics, including firm
size, risk, competition, product types, and earnings response coefficients (Lev,
1983; Collins and Kothari, 1989; Easton and Zmijewski, 1989). Other studies
indicate that weights assigned to accounting earnings in determining the size
and the change of executive compensation also depend on firm-specific factors
such as investment opportunities and the cashflows-versus-accruals composi-
tion of reported earnings (Gaver and Gaver, 1993; Baber et al., 1996; Natarajan,
1996). Thus, we investigate whether the primary results can be attributed to
these firm-specific characteristics that can be correlated with measures of earn-
ings persistence. We find that the primary results are robust after considering
these characteristics.
The next section outlines the arguments that guide our expectations about the
role of earnings persistence. The data are described in Section 3. The primary
empirical tests are presented and discussed in Section 4. Additional analyses
that support the primary results are reported and discussed in Section 5.
Section 6 summarizes the implications of the study.
172 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193

2. Unexpected accounting earnings and executive compensation

2.1. Earnings innovations and earnings persistence

We adopt an IMA(1,1) time-series characterization of earnings, which facili-

tates parsimonious empirical specifications of both earnings innovations and
earnings persistence (Beaver, 1970; Beaver et al., 1980; Ali and Zarowin, 1992b).
In particular,
X !X "ºE(X )!! ºE(X ), (1)
! !$" ! !$"
where period t earnings innovation ºE(X ) is i.i.d., and ! is assumed to be
!
firm-specific. If !"0, then earnings follow a random walk process, and all
earnings innovations are expected to be permanent (persistent). In contrast,
when !"1, earnings follow a mean reverting process, and all earnings innova-
tions are expected to be transitory. Thus, the parameter (1!!), which measures
the extent that earnings innovations are permanent versus transitory, quantifies
the notion of earnings persistence.#

2.2. The compensation function

Existing studies indicate contemporaneous correlations between stock re-

turns and executive compensation (Murphy, 1985; Coughlan and Schmidt, 1985;
Jensen and Murphy, 1990), and between accounting earnings and executive
compensation (Lambert and Larcker, 1987; Dechow et al., 1994). Rosen (1992)
and Holmstrom (1992), in particular, note the need for considering both ac-
counting and security performance indicators when analyzing executive com-
pensation arrangements. Thus, meaningful specifications of relations between
compensation and firm performance include both accounting earnings and
common stock returns as explanatory variables. Following Lambert and
Larcker (1987), Jensen and Murphy (1990), and Baber et al., (1996), we consider
a CEO compensation function
!COMP "" #" ºE(R )#" ºE(X )#e , (2)
"!! % " "!! # "!! "!!
where for firm i and period t, !COMP is the change in executive compensa-
"!!
tion, ºE(R ) is the unexpected common stock return, and ºE(X ) is the
"!! "!!
earnings innovation. The intuition behind expression (2) is that changes in
compensation respond to unexpected performance in accounting earnings and
security returns — in particular, we expect " '0 and " '0.
" #

# Results using (1!!) to measure earnings persistence are reported as primary results. We also
report results for alternative measures of earnings persistence that are suggested in the extant
literature.
 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193 173

The principal focus is on the parameter " , which indicates the sensitivity of
#
compensation to earnings innovations. In particular, we are interested in how
" varies with earnings persistence. For the IMA(1,1) characterization of earn-
#
ings time series, it can be shown that the expected present value of earnings
innovations is [1#(1!! )/r]ºE(X ), where ! is the IMA parameter for firm
" "!! "
i and r is the equity discount rate.& The unity in the brackets reflects the value of
current-period earnings innovations, while the quantity (1!! )/r indicates the
"
present value of ‘persistent’ effects of the earnings innovation. Note that
[1#(1!! )/r] increases in persistence. If earnings equal cashflows, if earnings
"
time series follow the IMA(1,1) process, and if compensation committees assign
equal weights on current earnings innovations and discounted values of ex-
pected earnings in each future period (dollar-for-dollar), then the coefficient on
ºE(X ) equals [1#(1!! )/r] times a certain (positive) proportionality con-
"!! "
stant — that is, " ""[1#(1!! )/r], "'0. All three conditions may not hold
# "
in practice, but in general, we expect " to be increasing in persistence (1!! ).
# "
More formally, we specify " "# ## (1!! ), where # '0. Thus (expres-
# " # " #
sion) (2) becomes
!COMP "" #" ºE(R )#[# ## (1!!)]ºE(X )#e , (3)
! % " ! " # ! !
where firm subscripts i are suppressed to ease the exposition.
The following hypothesis, stated in the alternative form, applies.

H : The sensitivity of CEO compensation to unexpected earnings increases with

'
the extent that earnings innovations are persistent (# '0).
#
A related issue is how associations between compensation changes and
accounting earnings depend on whether compensation takes the form of cash
or stock. Note that security prices incorporate both the short-run and the
long-run consequences of managers’ actions. Thus, conditioning security returns
on earnings persistence can be redundant. To the extent that equity-based
compensation, such as stock options and restricted stock, is determined by
security returns, we expect accounting earnings — and earnings persistence, in
particular — to play a more dominant role in the determination of cash, than
stock-based, compensation components.
Two streams of the literature support this characterization. First, a number
of studies indicate that the permanent versus transitory distinction is im-
pounded in security prices (Kormendi and Lipe, 1987; Collins and Kothari,

& Formal analysis indicates that, if earnings persistence is rewarded, then the sensitivity of
compensation to earnings innovations can vary with the discount rate (r). We demonstrate later that
empirical results are robust to a consideration of the discount rate.
174 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193

1989).( Second, results in Baber et al. (1996) indicate that relations between
accounting earnings and cash compensation are more substantial (that is,
relations are greater both in magnitude and statistical significance) than rela-
tions between accounting earnings and stock-based compensation.

3. Data and sample selection

CEO compensation data are from 1992 and 1993 proxy statements for 2009
publicly traded US firms that responded to a mail request to provide statements
for both years. We address compensation changes, and therefore, we omit 172
firms where the CEO does not serve at least two consecutive full years during
the 1991—93 period.) Financial data are from the 1993 COMPUSTAT primary,
secondary, or tertiary data files. Eliminating firms that lack the data required to
compute variables — primarily ! — or where estimates of ! do not converge,
leaves 713 firms. In some cases, we have useable data for only one year.
Excluding outliers using procedures described in Belsley et al. (1980) yields
a maximum of 1268 firm-year observations for the primary analysis. Disclosures
required since 1992 by the US Securities and Exchange Commission permit
meaningful valuations of both cash and equity compensation and also permit
decompositions of total compensation into cash versus non-cash and salary
versus bonus components.*
Table 1 summarizes selected characteristics of the sample firms. Industry
distributions are in panel A, and descriptive statistics are in panels B,C, and D.
Profiles for 1992 and 1993 are comparable, and therefore, we report only the
1993 summary. Statistics displayed in panel B for CEO compensation indicate
that the distribution of deferred compensation (primarily the value of stock
options and restricted stock awards) is highly skewed and also has a relatively

( If security prices are a sufficient statistic for the agent’s actions, then not only earnings
persistence, but also earnings itself, is redundant. We observe, however, that accounting earnings is
used in executive compensation contracts, which suggests that earnings offer incremental informa-
tional and/or risk-sharing benefits (Sloan, 1993).
) If reported salaries are pro-rated for CEOs who serve less than a full year, then compensation
changes are over- or under-stated. Note that 1992 is the first year that firms disclose executive
compensation details. Thus, we obtain 1991 and 1992 data from 1992 proxy statements and 1993
data from 1993 statements.
* Stock option values are computed using the Black and Scholes (1973) approach, adjusted to
consider the possibility of early exercise (Hemmer et al., 1994). For relatively few cases where details
required to apply the methodology are omitted, we assume that vesting occurs two years after the
grant and that the exercise period is identical to the period for the most recent option where the
exercise period is provided. Items designated as ‘other’ compensation — for example, the use of an
automobile — are excluded from computations of total compensation and compensation compo-
nents. Alternative values, computed using the Black—Scholes approach without adjusting for early
exercise, do not materially affect the results.
 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193 175

Table 1
Characteristics of sample firms!

Panel A: Distributions of sample firms across industries!

Industry Number of firms

Basic industries 50
Capital goods 168
Construction 28
Consumer goods 245
Energy 38
Financial services 78
Transportation 25
Utilities 81
Total 713

Descriptive statistics (1993)"

n Mean Median Std. dev.

Panel B. CEO compensation ($ thousands)

Total compensation 688 997 627 1,126

Cash salary plus bonus 689 642 495 524
Stock-based compensation 688 355 59 795
Cash bonus 689 218 110 339

Panel C: Dependent variables: percent change in compensation

Total compensation 635 0.218 0.035 1.047

Cash salary plus bonus 649 0.085 0.025 0.374
Stock-based compensation 368 0.477 !0.029 4.573
Cash bonus 467 0.159 0.011 1.210

Panel D: Independent variables:

Stocks returns [RE¹] 649 0.169 0.092 0.498

Earnings innovations [ºE(X)] 649 0.041 0.018 0.394
Earnings persistence# [PERSIS¹] 649 0.857 0.854 0.300

!Total firms with usable data for 1992 or 1993 or both years. Industry classifications are from Ali and
Kumar (1994).
"Descriptive statistics for 1992 are comparable.
#Earnings persistence (1!!) is computed from !X "ºE(X !!ºE(X ), where X is year
! ! !$" !
t"1974 through 1993 earnings per share before extraordinary items (COMPUSTAT data item
!58).

high variance. Moreover, although most firms have stock option plans (or
similar deferred compensation plans), less than one-half awarded such compen-
sation in 1993. Note that dependent variables, displayed in panel C, are
computed as percent changes. Finally, the mean (median) value of the IMA
176 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193

parameter (1!!) is 0.857 (0.854) using 1974—1993 earnings per share

data.+ This estimate is comparable to the median point estimate of 0.85 reported
in Ali and Zarowin (1992a) using a different sample and time period (1970—1988).
Finally, the requirement that firms have earnings time-series sufficient to
compete ! potentially restricts our ability to generalize results. To investigate
this issue, we compare the sample observations with approximately 1400 obser-
vations that are excluded owing to data availability. We find that the excluded
firms are smaller than the sample firms, but they perform comparably. In
particular, both book values of total assets and market values of equity for
excluded firms are substantially less (statistical comparisons are significant for
#(0.01), but both accounting performance (accounting earnings deflated by
the book value of stockholders’ equity) and security returns realized during 1992
and 1993 are comparable (two-tailed #'0.10). Our specific concern then, is
whether these size differences indicate structural differences in relations between
compensation and performance, and in particular, whether they undermine the
use of accounting earnings to set executive compensation. Regressions of
changes in executive compensation on security returns and changes in
accounting performance indicate that compensation-accounting performance
relations are positive and statistically significant for the excluded firms
(t"4.65), although a Chow test indicates that these relations are less substantial
than those for the larger firms that comprise the sample (t"2.09)., These
analyses suggest a cautious interpretation of the results with respect to the
smaller, omitted firms to the extent that accounting performance is less impor-
tant as a determinant of executive compensation.

4. Primary analysis

4.1. The regression specification

We estimate the following specification of expression (3):

!COMP "$ #$ RE¹ # $ RE¹ *PERSIS¹

"!! % " "!! # "!! "!!
-#. -%/$.
#$ ºE(X )#$ ºE(X )*PERSIS¹
& "!! ( "!! "!!
-$. -#.
#$ PERSIS¹ #% , (4)
) "!! "!!
-$.
+ We require a minimum of 12 annual earnings observations during the period 1974—1993 to
estimate !. Firms are omitted when they do not satisfy this criterion.
, Similar results obtain when earnings levels are included in the specification.
 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193 177

where
!COMP "year t!1 to year t percent change in firm i CEO compensation
"!!
specified as either (i) cash compensation defined as cash salary plus cash bonus,
(ii) total compensation defined as the sum of cash plus stock-based compensa-
tion, (iii) stock-based compensation defined as the value of stock options, stock
appreciation rights, phantom stock, or restricted stock, or (iv) cash bonuses;0
RE¹ " firm i, year t (raw) common stock return;
"!!
ºE(X )" firm i, year t unexpected earnings per share before extraordinary
"!!
items (computed using COMPUSTAT data item !58 in expression 1), deflated
by the beginning of the year book value per share of stockholders’ equity
(COMPUSTAT data item !60 divided by COMPUSTAT data item !25);
PERSIS¹ " firm i, year t earnings persistence estimated as (1!! ) from
"!! "
expression (1) using 1974—1993 annual earnings per share before extraordinary
items (COMPUSTAT item !58);
$ (k"0,2,5)" regression parameters;
$
% "error term;
"!
and where predicted signs for the estimates are displayed parenthetically."%
Five features of the model require elaboration. First, we address four speci-
fications of the dependent variable !COMP. The motive for doing so is to
evaluate whether various compensation components are structured differently,
and in particular, to ascertain whether and how earnings persistence interacts
with relations between the accounting earnings measures and changes for each
compensation metric.
Second, following Lambert and Larcker (1987), we use raw common stock
returns RET as a proxy for unexpected security returns ºE(R). This procedure
assumes that expected security returns are both cross-sectionally and inter-
temporally constant. Other studies that make this assumption include Jensen
and Murphy (1990) and Baber et al. (1996). Results (not reported) are compara-
ble for risk-adjusted, market-adjusted, and industry-adjusted common stock
return specifications of ºE(R).
Third, computations of the measure PERSIS¹, which indicate the extent that
earnings are persistent, involve straightforward applications of expression (1) to

0 Prior studies (e.g. Dechow et al., 1994; Gaver and Gaver, 1998) address compensation levels,
rather than changes. We use compensation changes to control for a large number of factors that vary
cross-sectionally across the sample firms, and that are shown in prior studies to influence compensa-
tion levels. Such factors include firm size, the CEO’s age, tenure and stock holdings, the composition
of the board of directors, and other corporate governance-related factors (Core et al., 1998; Cyert et
al., 1998). Also, results are comparable when dependent variables are computed, as in Baber et al.
(1996), as the change deflated by the base salary in the prior year.
"% Note that (0) indicates that we do not expect the estimate to be statistically significant and (?)
indicates that we make no prediction about the direction of the effect.
178 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193

obtain firm-specific maximum likelihood estimates of the parameter ! (Ali and

Zarowin, 1992b). Estimates of !, which in theory are 1 for a mean-reverting
process and 0 for a random walk process, vary inversely with earnings persist-
ence, and therefore, we use (1!!) as a measure of PERSIS¹ to obtain
empirical measures that vary directly. Alternative measures of earnings persist-
ence are considered later as refinements to the primary analysis.
Fourth, the variables RE¹ *PERSIS¹ and PERSIS¹, which are not implied
by the formal analysis (Eq. (3)), are included in the empirical specification to
examine whether earnings persistence interacts with security returns or has
explanatory power as a main effect. We expect the estimate $ on
#
RE¹ *PERSIS¹ to be non-positive for two reasons. First, the existing evidence
is that earnings persistence is properly impounded in security prices (Kormendi
and Lipe, 1987; Collins and Kothari, 1989). If so, then conditioning relations
between compensation and security returns on earnings persistence is redund-
ant. This reasoning implies $ "0. On the other hand, if earnings persistence
#
increases reliance on accounting earnings, then compensation committees may
substitute accounting earnings for security returns. If so, then we expect $ (0.
#
We note at this point that results are robust with respect to the inclusion or
exclusion of these two variables from the specification.
Fifth, since we use cross-sectional data, both the dependent and independent
variables are scaled by appropriate deflators. Consistent with the use of security
returns as an explanatory variable, and to preserve the use of a pure ac-
counting-based performance measure, we scale unexpected earnings by begin-
ning of the year book value of owners’ equity such that unexpected accounting
earnings can be interpreted as unexpected ROE. Security return and accounting
return computations are deflated to control for size-related factors, and thus, we
specify dependent variables as percent changes.
The parameter estimate $ on ºE(X)*PERSIS¹ addresses the hypothesis,
(
and thus, is the principal focus of the study. Under the (null) hypothesis that the
sensitivity of CEO compensation to earnings innovations is unaffected by
earnings persistence, the parameter $ is zero. Under the alternative hypothesis,
(
the weight assigned to earnings innovations increases as earnings persistence
(PERSIS¹) increases, and thus, the estimate $ for the interaction
(
ºE(X)*PERSIS¹ is positive.
Expectations for other parameters are as follows. Given the well-documented
role of stock returns in rewarding managers, we predict positive relations
between compensation and security returns RE¹($ '0). Finally, if accounting
"
income plays a role in executive compensation, then we expect positive relations
between compensation changes and unexpected earnings. In particular, if
ºE(X)*PERSIS¹ is not in the specification, or if earnings persistence is irrel-
evant to executive compensation, then we expect positive signs for the
estimate $ . If earnings persistence is relevant, however, then both estimates
&
$ and $ indicate the overall relation between compensation and earnings
& (
 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193 179

innovations. That is, predictions about the sign of $ on the main effect need to
&
be interpreted in conjunction with the estimate $ on the interaction. Thus, we
(
are uncertain about the sign on the estimate $ .
&

4.2. Results

Results for regression model (4), displayed in Table 2, support the hypothesis
specifically, and more generally, the discussion in Section 2. When compensa-
tion is specified as the cash salary and bonus component and earnings persist-
ence is not considered (column !1), relations between compensation changes
and unexpected earnings are positive and statistically significant. Notice that, in
the context of expression (3), $ in column !1 is an estimate of the average of
&
[# ## (PERSIS¹ )] for all firms, which is positive. This estimate can be
" # "
biased, however, since the specification does not permit PERSIS¹ to vary
"
across firms.""
Results when earnings persistence is considered (column !2) indicate a posi-
tive, statistically significant estimate $ on the interaction ºE(X)*PERSIS¹,
(
which implies that the role of unexpected earnings varies directly with earnings
persistence. The estimates $ and $ , evaluated for an average firm with
& (
a persistence parameter (PERSIS¹) of 0.857, indicate that, if current period
unexpected earnings are 10% of equity, then salary and bonuses increase by
approximately 2.2%, which substantially exceeds the 0.6% increase indicated by
the restricted specification in column !1."# Relations are similar when compen-
sation is specified as changes in cash bonus (column !3) but, not when specified
as changes in stock-based compensation components (column !4). Results for
total compensation are weak (column !5), as one would expect given the results
for compensation components. Finally, for specifications of cash salary and
bonus and of total compensation, estimates $ on the interaction between
#
security returns and earnings persistence are negative and marginally significant
(#(0.11). This relation provides some evidence of the substitution of ac-
counting returns for security returns as accounting earnings become more
persistent.

"" More specifically, [# ## (PERSIS¹ )]ºE(X ) can be expressed as [d #d ]ºE(X )"

" # " " % " "
d ºE(X )#d ºE(X ), where d is the mean [# ## (PERSIS¹ )] and d is the firm-specific
% " " " % " # " "
deviation from the mean. The term d ºE(X ), which is an omitted variable in the restricted
" "
specification displayed in column !1, is negatively correlated with ºE(X ). This implies that the
"
estimate $ is biased downward.
&
"# In particular, $ #$ PERSIS¹"!0.1487#(0.4292!0.857)"0.219. Thus, compensation
& (
increase by 0.219!10%"2.19%.
 180

Table 2
OLS specifications of percent changes in compensation on security returns and earnings innovations

Dependent variable — percent changes in:

Cash salary and bonus Cash bonus Stock-based Total

Coefficient/variable Pred. sign Restricted Full only compensation compensation
model model only

Column ! !1 !2 !3 !4 !5
$ /intercept 0.0373 0.0300 0.0766 0.0387 0.0341
%
(4.89) (1.30) (0.50) (0.15) (0.49)
$ /security return 1 0.2072 0.2698 0.7932 1.1265 0.7407
"
RE¹ (11.10) (5.07) (2.32) (1.57) (4.66)
$ /security return * persistence 0/! n.a. !0.0953 !0.0494 !0.3913 !0.3397
#
RE¹*PERSIS¹ (!1.62) (!0.13) (!0.49) (!1.90)
$ /earnings innovations ? 0.0602 !0.1487 !0.7352 !0.2375 !0.0809
&
ºE(X) (2.35) (!2.93) (!2.11) (!0.55) (!0.53)
$ /earn. innovations * persist 1 n.a. 0.4292 2.1202 0.7618 0.2981
(
ºE(X)*PERSIS¹ (4.75) (2.68) (0.91) (1.11)
$ /earnings persistence ? n.a. 0.0096 !0.0212 0.2639 0.0992
)
PERSIS¹ (0.38) (!0.13) (0.95) (1.30)
adjusted R# 0.102 0.116 0.062 0.015 0.059
number of observations 1,261 1,261 897 712 1,251

Entries are parameter estimates and t-statistics (in parentheses). Note that (0) indicates that we do not expect the estimate to be statistically different
from zero; (?) indicates that we make no prediction about the direction of the effect; n.a. indicates that the variable is not included in the model.
W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193

Observations are omitted as outliers when ‘dffits’ exceeds 2"(p/n), where p is the number of parameters in the model and n is the number of
observations (Belsley et al., 1980).
Specification for column !1
!COMP "$ #$ RE¹ #$ ºE(X )#%
"!! % " "!! & "!! "!!
Specification for columns !2—5
!COMP "$ #$ RE¹ #$ RE¹ PERSIS¹ #$ ºE(X )#$ ºE(X )PERSIS¹ #$ PERSIS¹ #%
"!! % " "!! # "!! "!! & "!! ( "!! "!! ) "!! "!!
!COMP "year t!1 to year t percent change to firm i CEO compensation specified as either cash compensation defined as cash salary plus cash
"!!
bonus (column !1 and !2), cash bonus only (column !3), stock compensation defined as the value of stock options, stock appreciation rights,
phantom stock, or restricted stock (column !4), or total compensation defined as the sum of cash plus stock compensation (column !5);
RE¹ "firm i, year t (raw) common stock return;
"!!
ºE(X )" firm i, year t unexpected earnings per share before extraordinary items (COMPUSTAT data item ! 58), computed using expression (1),
"!&
deflated by the beginning of the year book value per share of stockholders’ equity (COMPUSTAT data item ! 60/COMPUSTAT data item ! 25);
PERSIS¹ "firm i, year t earnings persistence — in particular, (1!!) estimated from expression (1) — defined in terms of the extent that 1974—1993
"!&
annual earings per share before extraordinary items (COMPUSTAT item ! 58) follow a random walk process;
$ (k"0,2,5)" regressions parameters.
'
W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193
181
182 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193

5. Refinements

Additional procedures are designed to investigate the plausibility of the

assumptions that underlie our interpretations of the primary results in Table 2.

5.1. Alternative measures of earnings persistence

The variable PERSIS¹ is central to the study, and thus, we examine whether
the primary results hold for alternative measures of earnings persistence. We
consider three measures. The first is the variance ratio (»R), described in
Cochrane (1988) and adapted to the analysis of earnings time series by Lipe and
Kormendi (1994) and Kang et al. (1995). The use of ! presumes that earnings
follow an IMA(1,1) process, whereas »R imposes no such restriction on the
time-series process. Although this feature favours the use of »R, it is unclear
whether the »R measure dominates ! for short time series.
The second measure is the firm’s earnings response coefficient (ERC), use of
which is motivated by the well-documented positive association between ERC
and earnings persistence (Kormendi and Lipe, 1987; Easton and Zmijewski,
1989; Collins and Kothari, 1989; Ali and Zarowin, 1992a)."& ERCs are estimated
for each firm, using data for up to 20 preceding quarters, by regressing both
levels (NI) and changes (!NI) in quarterly earnings before extraordinary items
deflated by beginning of period market value of equity on security returns."(
Finally, the third measure presumes relations between earnings-price ratios
(E/P) and the extent that earnings are persistent. This measure is motivated by
Beaver’s (1998) suggestion that extreme E/P are, to an extent, attributable to
investor perceptions that reported earnings contain sizable transitory compo-
nents.") Thus, following procedures proposed and described in Ou and Penman
(1989), we use E/P to consider earnings persistence, and then employ a dummy
variable to distinguish 1163 observations where earnings are presumed to be
persistent (i.e., those with moderate E/P) from 931 observations where earnings
are presumed transitory (extreme E/P observations)."* Although E/P is a noisy

"& ERCs are affected by factors other than earnings persistence. For example, evidence in Collins
and Kothari (1989) indicates that ERCs are determined in part by firm risk, prevailing interest rates,
and earnings growth rates.
"( The regression model is R "& #& !NI #& NI #% , where !NI "NI !NI and
! % " ! # ! ! ! ! !$(
ERC"& #& . Results are comparable when R is specified as either raw returns or market-adjusted
" #
returns (computed using either value-weighted or equally-weighted market returns). R are cumulat-
ed over the three-month period moved ahead 30 days to accommodate delay in the disclosure of
quarterly earnings.
") As with ERC, E/P is affected by factors other than earnings persistence. Beaver (1998) describes
how E/P varies with expected earnings growth and discount rate.
"* A more detailed explanation of this procedure is in the notes to Table 3.
 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193 183

measure of earnings persistence, its advantage is that the measure does not
require time-series estimation, and therefore, potentially offers a more timely
indication of earnings persistence.
Results for these alternative measures of earnings persistence are presented in
Table 3. Relations between compensation changes and accounting performance
($ and $ ) for the »R measure are similar to the primary results in Table 2.
& (
Relations for the E/P and ERC measures also are similar, except that the main
effect on unexpected earnings, which is negative and statistically significant for
the other measures, is positive but not significant at usual confidence levels
(#'0.10).

5.2. Competing explanations and potentially omitted variables

A related issue is that earnings persistence may be correlated with other

factors that can also influence weights assigned to accounting earnings in
compensation. If so, the documented relations in Table 2 for earnings persist-
ence can be spurious. The literature suggests at least four issues that need to be
considered.
First, evidence in Lev (1983) indicates that the statistical properties of earn-
ings time series are related to several economic factors. In particular, Lev reports
statistically significant relations between measures of serial correlation (a proxy
for earnings persistence) and other factors such as capital intensity, industry
concentration, firm size, and product type (durable versus non-durable goods).
Second, our estimation model (Eq. (4)) does not consider the cost of capital, and
therefore, we examine whether the primary results are attributed to cross-
sectional differences in the cost of capital. Third, Kumar et al. (1993) and
Natarajan (1996) examine the role of operating cash flows versus accounting
accruals in the context of executive compensation. Evidence reported in these
studies suggests that the importance of accounting earnings varies directly with
the extent that cashflows determine reported earnings. Finally, recent studies of
the determinants of CEO compensation indicate that the relative weights
assigned to accounting earnings versus security returns depend on the extent
that investment opportunities comprise firm value (Smith and Watts, 1992;
Gaver and Gaver, 1993; Baber et al., 1996).
We consider the following nine variables to address concerns implied by these
studies."+ To consider Lev’s (1983) results, we use (i) Herfindahl—Hirschman
index (a proxy for industry concentration) based on four-digit standard indus-
trial code (SIC) classifications, (ii) log book value of total assets, (iii) capital
intensity, and (iv) durable—nondurable industry classification. To consider cost

"+ Detailed computations of these variables are described in the notes to Table 4.
 184

Table 3
OLS specifications of percent changes in CEO salary and cash bonuses on security returns and unexpected earnings for alternative measures of
earnings persistence

Parameter/variable Pred. Sign Persistence measure (PERSIS¹)

»R Variance ratio E/P Earnings price ratio ERC Earnings response

coefficient

Column ! !1 !2 !3
$ /intercept 0.0325 0.0200 0.0288
%
(3.58) (2.64) (4.14)
$ /security return 1 0.2435 0.1832 0.2005
"
RE¹ (9.80) (10.01) (12.58)
$ /security return * persistence 0 !0.0520 !0.0015 !0.0007
#
RE¹*PERSIS¹ (!1.81) (!0.06) (!0.47)
$ /earnings innovations ? !0.0702 0.0185 0.0175
&
ºE(X) (!2.60) (1.42) (1.27)
$ /earnings innovations * persist. 1 0.2317 0.1755 0.0163
(
ºE(X)*PERSIS¹ (4.05) (2.94) (2.05)
$ /earnings persistence ? !0.0077 0.0066 !0.0006
)
PERSIS¹ (!0.89) (0.62) (!0.95)
adjusted R# 0.127 0.124 0.126
number of observations 1,733 2,094 1,632

Entries are parameter estimates and t-statistics (in parentheses). Observations are omitted as outliers when ‘dffits’ exceeds 2"(p/n), where p is the
number of parameters in the model and n is the number of observations (Belsley et al., 1980). Differences in sample size are attributable to data
W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193

availability.

»ariance ratio (»R), computed as (1/k) times the variance of k-differences deflated by the variance of first differences, varies directly with the extent the
earnings time series are permanent versus transitory. See Cochrane (1988), Lipe and Kormendi (1994) and Kang et al. (1995) for details.
Earnings price ratio (E/P) is a dummy variable specified as follows. E/P are computed as the net income before extraordinary items (COMPUSTAT
data item !18) deflated by the number of common shares (COMPUSTAT item !25) times the year-end price per share (COMPUSTAT item !199).
Observations are classified into ten portfolios using procedures in Ou and Penman (1989, p. 131). Observations with negative E/P are assigned to
portfolio 1. The remaining observations are distributed equally according to ranked E/P with portfolio 2 the lowest, and portfolio 10 the highest
ranked observations. The dummy variable is set equal to 1 for 1163 observations in portfolios 3—8 (high persistence), and set equal to 0 for 931
observations from portfolios 1, 2, 9, and 10 (low persistence).

Earnings response coefficients (ERC) are estimated for each firm by regressing both levels (NI) and changes (!NI) in quarterly earnings before
extraordinary items deflated by beginning of period market value of equity on security returns (R) cumulated over the three-month period moved
ahead one month to accommodate delay in disclosures of quarterly earnings. The regression model is R "& #& !NI #& NI #% , and
! % " ! # ! !
ERC"& #& . The model is estimated over a maximum of 20 quarters during the period 1989—1993.
" #
See notes to Table 2 for the specification, variable definitions, and explanations for predicted signs.
W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193
185
186 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193

of capital, we use both traditional CAPM-based measures that determine the

relative cost of equity financing — (i) firm BETA and a (ii) year dummy variable
to consider prevailing risk-free rate of return — and (iii) the ratio of market to
book value of equity, as suggested by Fama and French (1993, 1995). To
distinguish observations according to the extent that cashflows versus accruals
determine reported earnings, we use dummy variables based on the ratio of
absolute accruals over absolute value of cashflows (Natarajan, 1996). Finally,
investment opportunities are considered using a measure advanced in Baber et
al. (1996).
We execute two procedures to examine the effects of these potentially corre-
lated factors. First, we construct regression specifications that include the
independent variables from expression (4), along with main effects and two
interactions (one with earnings innovations and another with stock returns) for
each of these nine variables. The results support the primary findings displayed
in Table 2, but owing to the presence of 20 interaction variables (10 each on
RE¹ and ºE(X)), there is evidence of severe multicollinearity.
As a result, we consider a second, more parsimonious two-step procedure. In
the first step, we regress PERSIS¹ on the nine variables discussed above.
Residuals from this first-step specification, designated R—PERSIS¹, can be
interpreted as the variation in PERSIS¹ that is not explained by cross-sectional
differences in the nine firm-specific variables described above. In the second
stage, we estimate Eq. (4) using R—PERSIS¹ as the measure of earnings persist-
ence.",
Results for the second stage of the procedure, displayed in Table 4 for changes
in CEO cash compensation, are comparable to the primary results reported in
Table 2. An exception is that the estimate $ for earnings innovations is positive
&
and statistically significant. Overall, this evidence indicates that the primary
findings are robust when the effects of the correlated variables are considered
and eliminated from the earnings persistence measure.

5.3. CEO age

Theory and evidence in Gibbons and Murphy (1992) suggest that the horizon
problem becomes more consequential as managers move closer to retirement.
Moreover, in the particular context of earnings-based compensation, the effec-
tiveness of alternative mechanisms such as long-term performance plans (Teh-
ranian et al., 1987) diminishes as executives approach retirement, since these

", Note that this procedure differs from the procedure considered in Christie et al. (1984), which
addresses the case where regressors used in the first-stage specification are included in the second-
stage specification. Explanatory variables used in the first stage are not included in the specification
displayed in Table 4.
 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193 187

Table 4
OLS specification of percent changes in CEO salary and cash bonuses on security returns and
earnings innovations for persistence measure computed as the component (1!!) unexplained by
firm-specific characteristics

Entries are parameter estimates and (t-statistics); n"1093; adjusted R#"0.116

!COMP " $ #$ RE¹ #$ RE¹ *R—PERSIS¹ #$ ºE(X )

"!! % " "!! # "!! "!! & "!!
%2%&)( %2",+( $%2"&*& %2",&%
-(2(+. -02*). -$#2#). -(2),.
#$ ºE(X )*R—PERSIS¹ #$ R—PERSIS¹
( "!! "!! ) "!!
%2(%"( %2%"+#
-(2#%. -%2*(.
R—PERSIS¹ is specified as the residual (% ) from the following specification:
"!!

PERSIS¹ " # ## DºRAB¸E ## HH¸ ## CAPIN¹ ## MK¹2BK

"!! % " "!! # "!! & "!! ( "!!
%2*,*, %2%"00 %2#&% $%2%&%& $%2%%%0
-")2%". -%2%00. -&2)&. -$%2*". -$%2(,.
## ¸N¹A ## ½EAR ## BE¹A ## ACC2CFO ## IOS #% ,
) "!! * "!! + "!! , "!! 0 "!! "!!
%2%#"( $%2%%"% %2%#0" $%2%(+0 %2%*+&
-&2+). -$%2%*. -"2*#. -$#2),. -&2%*.
where
DºRAB¸E is a dummy variable that distinguishes firms that produce durable goods (coded 0) from
firms that either provide services or produce non-durable goods (coded 1) based on Survey of
Current Business (1993);
HHI is the mean annual 1974—1993 Herfindahl—Hirschman index, an indicator of industry concen-
tration computed as the sum of squared market shares for COMPUSTAT firms in the same
four-digit standard industrial code classification;
CAPIN¹ is firm capital intensity computed as the mean annual 1974—1993 ratio of net property,
plant, and equipment to total assets;
MK¹2BK is the ratio of market value to the book value of equity at the end of year t;
¸N¹A is the natural log of the book value of assets at the end of year t;
½EAR is a dummy variable that distinguishes 1992 from 1993 observations;
BE¹A is computed by regressing monthly returns on a value weighted market return index over the
60 month period from 1990 to 1994;
ACC2CFO is a dummy variable that distinguishes observations where the year t ratio of absolute
accruals to absolute operating cashflows exceeds the median from observations where the ratio is
less than the median;
IOS is the year t measure of the investment opportunity set computed as in Baber et al. (1996);
# (j"0,2,9) are regression parameters.
&

arrangements typically rely on the executive continuing in the labor market. To

investigate whether attention to earnings persistence increases to counterbal-
ance this problem, we expand expression (4) to consider the CEO’s age. Results
for salary and bonus are presented in Table 5.
The first five variables in the regression specification (parameters $ —$ ) are
% )
identical to those considered in Table 2. The last three variables (parameters
188 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193

Table 5
OLS specification of percent changes in CEO salary and cash bonuses distinguishing observations
where the CEO is sixty years of age or older

Entries are parameter estimates (t-statistics) and [variance inflation factors] n"1242; adjusted
R#"0.133

!COMP " $ #$ RE¹ #$ RE¹ *PERSIS¹ #$ ºE(X ) #$ ºE(X *PERSIS¹

"!! % " "!! # "!! "!! & "!! ( "!! "!!
%2%)#) %2#)&+ $%2%0%% $%2%",& %2#(*%
-#2##. -(2+&. -$"2)&. -$%2"). -"2+).
3,2,&04 302"#,4 3#)2"%"4 3"%2)("4
#$ PERSIS¹ #$ ºE(X *AGE60 #$ ºE(X )*PERSIS¹ *AGE60
) "!! * "!! "!! + "!! "!! "!!
%2%"0% $%2#+%0 %2)***
-%2+). -$"2,,. -#2)#.
3"2"*04 3#)2+,(4 3""2(0(4
#$ AGE60
, "!!
$%2%*)0
-$(2*(.
3"2%"*4
!COMP "year i, t!1 to year t percent change in firm i CEO compensation specified as cash
"!!
salary plus cash bonus;
RE¹ "firm i, year t (raw) common stock return;
"!
ºE(X )"firm i, year t unexpected earnings per share before extraordinary items (COMPUSTAT
"!!
data item !58), computed using expression (1), deflated by the beginning of the year book value per
share of stockholders’ equity (COMPUSTAT data item !60/COMPUSTAT data item !25);
PERSIS¹ "firm i, year t earnings persistence — in particular, (1!!) estimated from expression
"!!
(1) — defined in terms of the extent that annual earnings per share before extraordinary items
(COMPUSTAT item !58) follow a random walk process;
AGE60 "a dummy variable set equal to 1 for 538 (43.3%) observations where the CEO is 60 years
"!!
of age or older; set equal to 0, otherwise;
$ (k"0,2,8)"regression parameters.
$

$ —$ ) delineate incremental relations for CEOs who are likely approaching

* ,
retirement. In particular, a dummy variable AGE60, set equal to 1 for 538
observations (43.3% of the sample) where the CEO is 60 or more years of age,
and set equal to 0 otherwise, is used to construct these variables."0 The potential
for multicollinearity is high in this specification, and therefore, we report the

"0 The use of 60 years is arbitrary. Results are comparable for other cut-off points (63 and 65) for
distinguishing executives that anticipate retirement, and when specifying age as a Dechow and Sloan
(1991), Gibbons and Murphy (1992), and Yermack (1996) use similar approaches to distinguish
executives with short horizons. Comparisons of the subsample where the CEO is 60 years of age or
older, with the subsample where the CEO is younger, indicate that means of the independent
variables are not statistically significant. The mean percent change in salary and bonus compensa-
tion (the dependent variable) is statistically significant with younger CEOs experiencing mean
increases of 10.2% and older CEOs increases of 3.3% (t"4.73).
 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193 189

variance inflation factors, which indicate the extent that collinearity compro-
mises statistical tests of parameter estimates.#%
The statistically significant (#(0.05), positive estimate $ for the interaction
+
ºE(X)*PERSIS¹*AGE60 indicates the relative importance of earnings persist-
ence in determining accounting-based compensation to CEOs aged 60 and
older. The positive and statistically significant estimate suggests that compensa-
tion committees assign greater weight to earnings persistence for CEOs that
anticipate retirement. Finally, consistent with results in Gibbons and Murphy
(1992), the statistically significant, negative estimate for $ suggests that base
,
compensation increases to senior CEOs are less than increases paid to younger
CEOs.#"
In sum, evidence in Table 5 indicates a characterization where compensation
committees rely more heavily on earnings persistence when earnings are used as
a basis for contracting.

5.4. Other procedures

Economic theory suggests the use of relative, rather than absolute, perfor-
mance measures (Holmstrom, 1982). Prior empirical studies offer mixed evi-
dence with respect to the superiority of relative performance measures when
accounting measures determine executive compensation, however (Antle and
Smith, 1986; Gibbons and Murphy, 1990; Janakiraman et al., 1992). Even so, we
confirm that primary results reported in Table 2 are comparable for regression
specifications that include security return and accounting return metrics that are
adjusted for market and industry performance (results not reported).
Finally, we partition the observations into two equal subsamples according to
firm size (measured as revenue or total assets), according to investment oppor-
tunities (Baber et al., 1996), and then according to whether the ratio of cash-
based compensation is high or low. Results for subsamples delineated according
to size and investment opportunities are comparable to those for model 2 in
Table 2. Earnings-compensation relations are stronger for the subsample where
cash compensation is high. This finding is consistent with results in Table 2
which imply that earnings persistence plays a greater role in the determination
of cash-based, rather than stock-based, compensation.

#% Variance inflation factors in excess of 10 indicate multocollinearity. Note that the presence of
multicollinearity undermines the ability to achieve statistical significance.
#" Gibbons and Murphy (1992) also report that the sensitivity of compensation to security returns
is greater for executives approaching retirement. We find that relations between compensation
changes and variables that include ºE(X) are comparable to those in Table 5 for a specification that
includes RE¹*AGE60 and RE¹*PERSIS¹*AGE60 along with the other independent variables
displayed in the table. Thus, the evidence in Table 5 is not attributable to correlations between
accounting earnings and security returns.
190 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193

6. Concluding remarks

Our investigation of compensation paid to US CEOs suggests that the

persistence of accounting earnings is relevant for setting executive compensa-
tion. In particular, we find that pecuniary rewards for a specified level of
current-period earnings innovations vary directly with the extent that reported
earnings are expected to persist. Further investigation suggests that the role of
earnings persistence is greater for CEOs that are approaching retirement, and
that the focus on earnings persistence is robust to a variety of competing
explanations suggested by the extant literature. Finally, the analysis suggests
that earnings persistence is relevant to cash salary and bonuses, but not to
stock-based, compensation components.
Overall, the evidence is consistent with a characterization where compensa-
tion committees assign higher weights to persistent earnings in order to mitigate
the ‘horizon problem’ and induce managers toward value-maximizing actions.
At the same time, we recognize that there may be competing explanations and
that conditioning compensation on earnings persistence is only one way to
abate horizon problems that result from the use of accounting performance
measures. Other mechanisms include the use of stock-based compensation,
labor market discipline which discourages management behavior that contra-
dicts shareholder preferences (Fama, 1980), and the use of long-term compensa-
tion plans (Lewellen et al., 1987; Tehranian et al., 1987; Dechow and Sloan,
1991). Our interpretation then is that focusing on earning persistence comp-
lements other mechanisms advanced and investigated by prior studies.
In sum, the analysis indicates that executive compensation is influenced by the
economic substance of reported earnings, and therefore, implies an informed use
of accounting earnings in executive contracting arrangements. Thus, the analy-
sis contributes to the growing body of literature that addresses issues of how
compensation committees interpret reported earnings (Abdel-Khalik, 1985;
Healy et al., 1987; Dechow et al., 1994; Holthausen et al., 1995; Natarajan, 1996;
Gaver and Gaver, 1998).

Acknowledgements

Comments and suggestions by Anwar Ahmed (the referee), Scott Boylan,

Jennifer Gaver, Robert Lipe, Toni Nelson, Eric Press, Renee Price, Heibatollah
Sami, Nathan Stuart, Jerry Zimmerman (the editor), and workshop participants
at Boston College, CUNY-Baruch College, the University at Buffalo, the Col-
lege of William and Mary, Carnegie Mellon University, Georgetown University,
Temple University, Wake Forest University, the University of Wisconsin-
Madison, the 1997 National Conference of the British Accounting Association,
the 1997 Annual Congress of the European Accounting Association, the 1997
 W.R. Baber et al. / Journal of Accounting and Economics 25 (1998) 169–193 191

annual meeting of the Canadian Academic Accounting Association, and the

1998 annual meeting of the American Accounting Association are gratefully
acknowledged.

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