Segment disaggregation and equity-based pay contracts

Abstract

We study the role of segment disaggregation in equity-based pay contracts in diversified firms. Disaggregated segment disclosures can improve the observability of managerial actions in internal capital markets and thus increase implicit incentives for managers to allocate resources as desired by shareholders, substituting for explicit incentives provided to CEOs. We use the adoption of Statement of Financial Accounting Standards No. 131 as an identification strategy and find that firms affected by this segment reporting mandate significantly decreased the provision of equity-based incentives in the post-adoption period, especially for firms with higher operating volatilities. This effect is also more pronounced for firms with weaker board monitoring in the pre-adoption period but with stronger external monitoring in the post-adoption period. Overall, our results suggest that disaggregated segment disclosures reduce the use of equity-based pay contracts in diversified firms by enhancing the monitoring of managers.