The Impact of CEO Compensation Incentives on Financial Reporting Choices: Evidence from Potential Ghost Revenues Created in Mergers and Acquisitions

When an acquirer purchases a target and assumes the target’s deferred revenue liability, accounting standards codification 805 requires that the acquirer recognize the target’s deferred revenue at its estimated fair value as of the acquisition date. If the target’s deferred revenue book value exceeds its fair value, the portion of deferred revenue written down will never be recognized as revenue for the acquirer under generally accepted accounting principles (GAAP). In this study, I investigate the impact of chief executive officers’ (CEOs’) compensation incentives on the fair value measurement of deferred revenue liabilities in acquisitions. If a larger proportion of CEO cash incentive pay is based on performance metrics tied to GAAP revenue, CEOs have incentives to minimize deferred revenue write-downs because these write-downs reduce post-acquisition revenues. I predict and find that CEOs with a larger proportion of cash incentive pay based on performance metrics tied to GAAP revenue write down less deferred revenues. Additionally, I predict and find that CEOs with a larger proportion of cash incentive pay based on non-GAAP metrics that adjust for deferred revenues which would have been recognized as future revenues (i.e., ghost revenues) write down more deferred revenues. These results provide evidence that manager opportunism in fair value measurement following acquisitions extends to deferred revenue liabilities as well as assets.