Alignment between Compensation-Contracting and Value-Relevance Roles of Revenues

Revenue is the closest proxy in financial statements for market size and dominance, factors that often determine the survival and future profits of modern corporations. Hence, revenue may contain information relevant to investors’ decision making, in addition to the information contained in current earnings. We find that revenue is used as a performance metric in compensation contracts for managers when it provides information on equity valuation beyond the information provided by earnings. We call this occurrence an alignment between the contracting and the valuation roles of revenues. The alignment is higher for firms with investors who focus on the firm’s ability to beat revenue targets, with managers who provide revenue guidance, and with analysts who issue revenue forecasts, all of which reflect capital market participants’ interest in the firm’s revenue performance. The alignment is greater for newer industries and appears more prevalent in the stock option component of managerial compensation. This alignment seems efficient because revenue is more informative of future profits when firms accord higher weight to revenues in executive compensation. We conclude that modern corporations increasingly incentivize managers to create new markets and defend existing market shares, in addition to maximizing current profits