Accounting system quality and CEO compensation

This dissertation extends empirical studies of the pay for performance relation by examining whether accounting system quality increases the value of earnings as a CEO performance measure. Specifically, I define accounting system quality as the portion of accruals quality that is inherent to the accounting system. The prior literature documents that accruals quality and its components are priced in the equity market. Therefore, I hypothesize that both accruals quality and accounting system quality are positively associated with the signal-to-noise ratio of earnings, and thus they influence the incentive weight on earnings in CEO compensation contracts.; Following prior studies, I measure accruals quality as the standard deviation of residuals from annual industry regressions of current accruals on past, current and future operating cash flows. I find that accruals quality is positively related to the sensitivity of CEO cash compensation to earnings. I then adjust the measure of accruals quality by the volatility of business operations to derive a measure of accounting system quality. The evidence shows that accounting system quality is positively associated with the weight placed on earnings in determining CEO cash compensation, after controlling for the positive impact of accruals quality. Additional analyses suggest that both accruals quality and accounting system quality provide information regarding the usefulness of earnings in evaluating top executives incremental to other measures documented in the prior literature. However, robustness tests indicate that the incremental significance of accounting system quality in the presence of accruals quality is sensitive to alternative specifications.