CEO horizon problem and characteristics of board of directors and compensation committee

Date01 October 2020
AuthorZhenfeng Liu,Ruonan Liu
Published date01 October 2020
CEO horizon problem and characteristics of board
of directors and compensation committee
Ruonan Liu
| Zhenfeng Liu
University of the Pacific, Stockton,
University of Michigan-Flint, Flint,
Ruonan Liu, Eberhardt School of
Business, University of the Pacific, 3601
Pacific Ave., Stockton, CA 95211.
Extant research finds inconclusive evidence about the CEO horizon problem.
One possible explanation is that board of directors, especially compensation
committees, intervene to mitigate the CEO horizon problem. In this study, we
examine whether the characteristics of board of directors and compensation
committee affect their effectiveness in mitigating the CEO horizon problem.
We find that retiring CEOs are more likely to reduce R&D expenditures when
CEOs have more power, and director tenure is longer; retiring CEOs in firms
with large board of directors and compensation committee are less likely to
manage accruals.
board of directors, CEO horizon problem, compensation committee
CEOs face horizon problem. That is, CEOs with
earnings-based compensation may focus on boosting
firms' short-term performance at the expense of share-
holders' long-term interests. Extant research has found
inconclusive evidence about the CEO horizon problem.
One possible explanation for the mixed findings is that
compensation committees design CEO compensation in
such way that discourages retiring CEOs from opportu-
nistic earnings management (Cheng, 2004) and R&D
reduction (Huson, Tian, Wiedman, & Wier, 2012). Board
of directors (hence the board), especially the compensation
committee, is responsibl e to adjust CEO compensati on
package to alleviate this agency problem with myopic
horizon. However, not all directors are equally effective.
This study examines whether certain characteristics of the
board and compensation committee can affect the ability
to mitigate CEO horizon problem.
To effectively mitigate CEO horizon problem, the
board and the compensation committee need to act inde-
pendently and to align the interests of CEOs with those of
shareholders. The board and the compensation committee
should be aware of CEOs' horizon problem and adjust
their compensation packages accordingly.
Using a sample of 13,606 firm-year observations for
S&P 1500 firms from 1998 to 2011, we find that both
CEO power and director tenure increase the likelihood
of R&D curtailment when CEOs approach retirement.
sation committee decreases the likelihood of accruals
management when companies face a CEO horizon
This study contributes to the literature twofold. First, we
provide further empirical evidence to echo the debate over
CEO horizon problem. Previous studies (Cazier, 2011;
Dechow & Sloan, 1991; Gibbons & Murphy, 1992;
Kalyta, 2009; Murphy & Zimmerman, 1993; Pourciau, 1993)
provide mixed evidence of the horizon problem because
they do not consider the role of board and more specifically
CEO compensation package. Moreover, the study adds to
the literature on corporate governance, revealing that board
of director and compensation committees characteristics
affect the effectiveness of mitigating an organization's CEO
horizon problem.
Received: 15 December 2019 Revised: 20 March 2020 Accepted: 25 March 2020
DOI: 10.1002/jcaf.22446
J Corp Acct Fin. 2020;31:121134. © 2020 Wiley Periodicals, Inc. 121

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