THE EFFECT OF RESTRUCTURING CHARGES ON EXECUTIVES CASH COMPENSATION

Top executives' compensation contracts typically provide for annual in centive awards that link executives' cash compensation and reported ea rnings. This link has been confirmed empirically by Lambert and Larcke r (1987), who document a positive association between the cash compens ation of chief executive officers (CEOs) and their firms' contemporane ous earnings performance. The widespread use of earnings-based incenti ves has prompted concerns that executives may select real decisions an d accounting procedures to maximize their earnings-based compensation, irrespective of the impact on the economic well-being of the firm (Ka plan and Atkinson 1989, 724; Watts and Zimmerman 1986, 204). These con cerns presume that the earnings-based performance measures specified i n compensation contracts are strictly adhered to in setting executive compensation. In practice, however, these plans are administered by co mpensation committees, who could adjust compensation to prevent execut ives from engaging in opportunistic behavior. Existing research provid es mixed evidence as to whether compensation committees adjust earning s-based compensation. For example, Abdel-khalik (1985) finds evidence that CEO compensation is adjusted in response to accounting procedure changes. In contrast, Healy et al. (1987) find no evidence that CEO co mpensation is adjusted for the effects of accounting procedure changes on reported earnings. This study provides evidence suggesting that co mpensation committees do adjust earnings-based incentive compensation. It documents reliable and systematic evidence that CEOs' cash compens ation is adjusted for restructuring charges. We investigate a sample o f 182 restructuring charges taken by 91 Fortune 500 firms between 1982 and 1989. The short-term incentive plans of the sample firms do not i nclude explicit provisions for restructuring charges to be excluded fr om the definition of earnings used to determine executives' incentive compensation. The empirical analysis, however, indicates that CEO cash compensation is shielded from restructuring charges relative to other components of earnings. The results also suggest that the degree to w hich executive compensation is adjusted for a restructuring charge dep ends on the characteristics of the restructuring. Our evidence is cons istent with the hypothesis that compensation committees systematically override the provisions of incentive plans to avoid providing executi ves with incentives to behave opportunistically. Restructurings typica lly require a large charge to earnings but can have a positive impact on the economic well-being of a firm. By adjusting executive compensat ion for restructuring charges, the compensation committee ensures that executives are not deterred from undertaking value-enhancing restruct urings.