Hostname: page-component-7c8c6479df-hgkh8 Total loading time: 0 Render date: 2024-03-28T13:45:47.834Z Has data issue: false hasContentIssue false

Long-Run Investment Decisions, Operating Performance, and Shareholder Value Creation of Firms Adopting Compensation Plans Based on Economic Profits

Published online by Cambridge University Press:  06 April 2009

Chris E. Hogan
Affiliation:
chogan@mail.cox.smu.edu, Edwin L. Cox School of Business, Southern Methodist University, P.O. Box 750333, Dallas, Texas 75275
Craig M. Lewis
Affiliation:
craig.lewis@owen.vanderbilt.edu, Owen Graduate School of Management, Vanderbilt University, Nashville, Tennessee 37203.

Abstract

For firms that adopted economic profit plans between 1983 and 1996, we document changes in investment behavior that lead to improvements in operating performance and growth opportunities relative to these firms' past performance. The improvements, however, are similar to those realized by a set of non-adopting control firms that are selected on the basis of a logistic regression model of adoption choice. We then consider the possibility that some firms are better candidates for economic profit plans than others and classify adopters according to whether they make anticipated or surprising choices based on the adoption choice model. We find that anticipated adopters make changes in investment behavior that reduce invested capital and allow them to become more profitable than a sample of control firms that were expected to adopt but chose to continue using a traditional plan. A similar analysis of surprise adopters does not reveal significant performance differences relative to a sample of anticipated non-adopters. The classification analysis suggests that economic profit plans work best for firms that are expected to adopt such plans based on pre-adoption operating, organizational, financial, and compensation characteristics.

Type
Research Article
Copyright
Copyright © School of Business Administration, University of Washington 2005

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.)

References

Balachandran, S. V.How Does Residual Income Affect Investment? The Role of Prior Performance Measures.” Working Paper, Columbia Univ. (2003).Google Scholar
Barber, B., and Lyon, J.. “Detecting Abnormal Operating Performance: The Empirical Power and Specification of Test Statistics.” Journal of Financial Economics, 41 (1996), 359399.CrossRefGoogle Scholar
Biddle, G. C.; Bowen, R. M.; and Wallace, J. S.. “Does EVA Beat Earnings? Evidence on Associations with Stock Returns and Firm Values.” Journal of Accounting and Economics, 24 (1997), 301336.CrossRefGoogle Scholar
Biddle, G. C.; Bowen, R. M.; and Wallace, J. S.. “Evidence on EVA.” Journal of Applied Corporate Finance, 12 (1999), 6979.CrossRefGoogle Scholar
Charoenrook, A.The Role of Capital Structure in Tests of Asset-Pricing Models.” Working Paper, Vanderbilt Univ. (2002).Google Scholar
Cosslett, S. R.Maximum Likelihood Estimator for Choice-Based Samples.” Econometrica, 49 (1981), 12891316.CrossRefGoogle Scholar
Dehejia, R. H., and Wahba, S.. “Propensity Score Matching Methods for Non-Experimental Causal Studies.” Working Paper 6829, National Bureau of Economic Research (1998).CrossRefGoogle Scholar
Garvey, G. T., and Milbourn, T. T.. “EVA versus Earnings: Does it Matter Which Is More Highly Correlated with Stock Returns?Journal of Accounting Research, 38 (2000 Supplement), 209243.CrossRefGoogle Scholar
Hamilton, R.An Introduction to Merchandize. Edinburgh (1777).Google Scholar
Ittner, C. D., and Larcker, D. F.. “Assessing Empirical Research in Managerial Accounting: A Value Based Management Perspective.” Journal of Accounting and Economics, 32 (2001), 349410.CrossRefGoogle Scholar
Jung, K.; Kim, Y.; and Stulz, R.. “Timing, Investment Opportunities, Managerial Discretion, and the Security Issuance Decision.” Journal of Financial Economics, 42 (1996), 159185.CrossRefGoogle Scholar
Lehn, K., and Makhija, A.. “EVA, Accounting Profits, and CEO Turnover: An Empirical Examination 1985–1984.” Journal of Applied Corporate Finance, 10 (1997), 9097.CrossRefGoogle Scholar
Manski, C. F., and Lerman, S. R.. “The Estimation of Choice Probabilities from Choice Based Samples.” Econometrica, 45 (1977), 19771988.CrossRefGoogle Scholar
Murphy, K.Executive Compensation.” Working Paper, Univ. of Southern California (1998).Google Scholar
Myers, S., and Majluf, N.. “Corporate Financing and Investment Decisions when Firms Have Information that Investors Do Not Have.” Journal of Financial Economics, 13 (1984), 187221.CrossRefGoogle Scholar
Rosenbaum, P., and Rubin, D.. “The Central Role of the Propensity Score in Observational Studies for Casual Effects.“ Biometrica, 70 (1983), 4155.CrossRefGoogle Scholar
Wallace, J. S.Adopting Residual Income-Based Compensation Plans: Do You Get What You Pay For?Journal of Accounting and Economics, 24 (1997), 275300.CrossRefGoogle Scholar
Villalonga, B.Does Diversification Cause the 'Diversification Discount'?Financial Management, 33 (2004), 529.Google Scholar
Zimmerman, J.EVA and Divisional Performance Measurement: Capturing Synergies and Other Issues.” Journal of Applied Corporate Finance, 10 (1997): 98109.CrossRefGoogle Scholar