Revenue-Expense Matching and Performance Measure Choice


Recent research shows that matching between contemporaneous revenues and expenses has declined over the past 40 years. We argue that this decline in matching reduces the contracting usefulness of earnings and affects managerial effort allocation and performance measure choice. Based on a theoretical model, we predict that firms with low matching stipulate a compensation contract based on both sales revenue and earnings, whereas firms with high matching offer a compensation contract based on only earnings. Using hand-collected CEO performance measure data from S&P 500 firms, we document a significant increase in the use of sales revenue coupled with a significant decline in the use of bottom-line earnings as a performance measure over time. We confirm the model prediction that firms are more likely to explicitly employ sales revenue as a performance measure when matching is lower. We further show that this negative association between matching and the use of sales revenue performance is more pronounced for firms with higher sales noise, higher gross margins and operating in less competitive industries. This study contributes to the literature by explaining the effect of revenue-expense matching on compensation design and documenting the increasing trend of revenue-based compensation in recent years.