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Choosing the Precision of Performance Metrics

Published online by Cambridge University Press:  10 July 2018

Alan D. Crane ,
Andrew Koch  and
Chishen Wei
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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 

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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.

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