Are Incentive Contract Settlements Nonevents?*

Date01 December 2020
Published date01 December 2020
Are Incentive Contract Settlements
Department of Finance, Insurance and Real Estate, FSA Faculty of Business
Administration, Université Laval (Laval University), Quebec City, Canada
We examine the information conveyed in managersincentive 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 rms with lower visibility, CARs are signi-
cantly negative immediately after settlement, whereas rms with higher visi-
bility incur this effect upon signature. The signature and settlement dates
have a small negative effect on the rmsvolatility 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 rm-specic risk. While these practices can have a signicant
positive inuence on managerstax rate and diversication, they also allevi-
ate managerial incentives for performance and transparency, and therefore
their perception by nancial 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 scal
memo from the internal revenue service (Barnet 2006; Boczar and Engmann
2010). The Dodd-Frank act requires rms 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 nancial 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. 983992
DOI: 10.1111/ir.12247

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