ABSTRACT
This chapter discusses the relation between fair value measures reported in the financial statements and executive compensation. It begins with a brief discussion of the broader issue of the compensation relevance of accounting numbers, and other non-accounting measures. The chapter presents the desired properties of a measure that make it compensation relevant. Fair value accounting advances the timing of recognition of gains and losses. Since compensation schemes typically protect managers from incurring penalties when they fail to meet performance targets, an important issue that boards need to address is how to design compensation contracts that mitigate against the claw-back problem that arises when unrealized gains are recorded. It took some time for standard-setters to require fair value measurement for equity-based compensation owing to a stiff opposition mainly from executives and the big accounting firms. Disclosures enable various stakeholders to properly evaluate whether compensation is adequate, that it links to performance, and claw-back features deter scrupulous behavior.
