Choice of Performance Measure in a Bonus Plan: Managerial Opportunism Or Efficient Contracting?(Manuscripts‪)‬

ABSTRACT This paper tests why firms choose different accounting measures of performance when determining bonus payments. The two measures of performance examined are return on assets and return on equity. Empirical evidence suggests that when firms are smaller, have higher leverage, lower growth opportunities, and lower stock ownership by management they are more likely to choose the ROE performance measure as opposed to the ROA performance measure. The results imply that managerial opportunism may play a role in the choice of the accounting performance measure. Empirical evidence also weakly suggests that firms may have chosen the accounting measure due to lower noise in the measure and hence optimal contracting cannot be ruled out.