The Association between Employee Bonuses and Subsequent Firm Performance

The employee stock bonus plan is a commonly adopted incentive compensation scheme in Taiwan, especially in high-tech companies. The main purposes of granting huge employee bonuses to employees are to attract and retain excellent employees, to motivate them and to improve their working attitude. Furthermore, granting firms expect this incentive scheme will improve their future firm performance.
Under the current accounting practice in Taiwan, the employee bonuses are not recognized as compensation cost, which results in an overstatement of the reported earnings and induces excess distribution of employee bonuses. Since 2002, when foreign investors raised concerns about the adverse impact of this accounting treatment for the employee bonuses, it has become a hot topic in the Taiwanese stock market. The main purpose of this paper is to investigate the relationship between employee bonuses and subsequent firm performance.
This study finds that the employee bonuses have a weakly significant and positive incentive effect on subsequent firm performance. However, after adjusting subsequent operating performance by considering the expenses of employee bonuses, the results no longer support the hypothesis that higher bonus ratio will create better subsequent firm performance. This means that the dilution effect of the employee bonuses is greater than its incentive effect and that this is caused by an excess distribution of employee bonuses (or excess profit sharing). In addition, the results do not support the hypothesis that the higher the percentage of the stock bonus the better the subsequent firm performance.
The results suggest that managers should not distribute excess employee bonuses in order to improve corporate governance, but may adopt other effective compensation plans to motivate their employees. In addition, this paper suggests that regulatory agencies or accounting standards setting bodies have to amend the current accounting treatment to recognize the expenses of the employee bonuses. This would improve the reliability and transparency of financial reporting, and also help to generate a reasonable employee bonus plan.