A comparison of GAAP financial accounting reported information with alternative economic/financial measures of firm performance in compensating chief executive officers

Compensation of corporate executives has been a major controversy among shareholders and other financial stakeholders for many years. The main concern has been the effective compensation of corporate executives, especially the Chief Executive Officer (CEO), relative to the performance of the company. For example, is the measurement of company performance consistent with the executives' contribution to company performance? Are earnings and cash flows significant in the evaluation and compensation of CEOs?; Traditional financial accounting measures have not demonstrated the correlation expected between increases in shareholder wealth and executive compensation (Natarajan 1996; Mehran 1995; Jensen and Murphy 1990a). Generally Accepted Accounting Principles (GAAP) based information has provided the primary performance measures. The poor correlations may indicate that corporate executives' compensation is based on internal accounting measures or undisclosed economic performance evaluations.; Prior research (Natarajan 1992, 1996) is significant to this study. Natarajan tested the relationship between CEO compensation, GAAP earnings and two separate measures of cash flows. These studies es found a significant statistical relationship between CEO compensation and external financial reporting. This study will expand upon Natarajan's approach by employing enhanced, alternative measures of firm performance derived from financial accounting data, specifically Economic Value Added (EVA®) and Free Cash Flow (FCF).; EVA® and Free Cash Flow are considered more stringent measures of company operations. They may provide a higher correlation between firm performance and CEO compensation. These alternative performance measures may explain the relationship between comprehensive earnings and executive compensation.