Are Incentive Contract Settlements Nonevents?*

• DOI: http://doi.org/10.1111/irfi.12247
• Date: 01 December 2020
• Published date: 01 December 2020

Are Incentive Contract Settlements

Nonevents?*

MARIE-HÉLÈNE GAGNON AND AURÉLIEN PHILIPPOT

Department of Finance, Insurance and Real Estate, FSA Faculty of Business

Administration, Université Laval (Laval University), Quebec City, Canada

ABSTRACT

We examine the information conveyed in managers’incentive contracts

such as prepaid variable forward (PVF) contracts. Using a large database, we

perform event studies on cumulative abnormal returns (CARs) and volatility

around the signature and the settlement of such contracts. The results show

that PVF settlements, which involve no divulgation of new information, can

be interpreted as nonevents. For firms with lower visibility, CARs are signifi-

cantly negative immediately after settlement, whereas firms with higher visi-

bility incur this effect upon signature. The signature and settlement dates

have a small negative effect on the firms’volatility suggesting slow adjust-

ment mechanisms.

JEL Codes: G30; G34

Accepted: 18 October 2018

Since the 1990s, there have been considerable developments in incentive

contracts offered to managers and insiders in order to reduce their personal

exposure to firm-specific risk. While these practices can have a significant

positive influence on managers’tax rate and diversification, they also allevi-

ate managerial incentives for performance and transparency, and therefore

their perception by financial markets is not well documented (Bettis

et al. (2001)). To improve transparency, several regulation changes have

affected prepaid variable forwards (PVFs) such as the 2006 technical fiscal

memo from the internal revenue service (Barnet 2006; Boczar and Engmann

2010). The Dodd-Frank act requires firms to state in their annual reports

whether they authorize such deals. Despite these limitations, PVF contracts

continued to be signed beyond 2010.

There is no consensus in the literature regarding the motivations for and

effects of using such incentive contracts. Bettis et al. (2001) suggest that these

* The authors gratefully acknowledge financial support from SSHRC, FRQSC, la Chaire de recherche

Industrielle-Alliance, and les Salles des Marchés FSA Jean-Turmel et Carmand-Normand. Any errors

are our own. We thank Mark Garmaise, Ivo Welch, Richard Roll, Andrea Eisfeldt, and Eduardo

Schwartz for their comments.

© 2018 International Review of Finance Ltd. 2018

International Review of Finance, 20:4, 2020: pp. 983–992

DOI: 10.1111/irfi.12247