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Executive Compensation and Analyst Guidance: The Link between CEO Pay and Expectations Management

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Author Info

  • Guido BOLLIGER

    (HEC-University of Neuchâtel and FAME)

  • Manuel KAST

    (HEC-University of Lausanne and FAME)

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    Abstract

    During the last decade, a surprisingly high percentage of U.S. companies has fulfilled or beaten analysts’ earnings per share forecasts. One of the most frequently cited reasons for this growing tendency is a change in the nature of U.S. executive compensation structure. As stock options have become an increasingly important part of executive compensation, the preservation or enhancement of short term stock value around the earnings announcement has become a priority for managers. Besides earnings management, a widespread way to meet analyst expectations is to inject pessimism into their forecasts by providing analysts with negative clues, or so-called downward guidance. This paper is the first to investigate the relationship between the practice of analyst guidance and executive compensation packages. We document a strong link between expectations management and the relevant options component of CEO compensation, bonus plan payments, and the value of the firm's shares owned by its managing CEO. In a second set of tests, we show that firms that meet or beat analyst forecasts at the earnings announcement generate positive abnormal returns, which are significantly lower for firms suspected of managing expectations.

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    Bibliographic Info

    Paper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number rp102.

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    Date of creation: Nov 2003
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    Handle: RePEc:fam:rpseri:rp102

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    Related research

    Keywords: Analyst guidance; Earnings surprise; Executive compensation; Stock options;

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    References

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    1. Ron Kasznik, 2002. "Does Meeting Earnings Expectations Matter? Evidence from Analyst Forecast Revisions and Share Prices," Journal of Accounting Research, Wiley Blackwell, vol. 40(3), pages 727-759, 06.
    2. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
    3. Yermack, David, 1995. "Do corporations award CEO stock options effectively?," Journal of Financial Economics, Elsevier, vol. 39(2-3), pages 237-269.
    4. Bartov, Eli & Givoly, Dan & Hayn, Carla, 2002. "The rewards to meeting or beating earnings expectations," Journal of Accounting and Economics, Elsevier, vol. 33(2), pages 173-204, June.
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    7. Lin, Hsiou-wei & McNichols, Maureen F., 1998. "Underwriting relationships, analysts' earnings forecasts and investment recommendations," Journal of Accounting and Economics, Elsevier, vol. 25(1), pages 101-127, February.
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    9. Yermack, David, 1997. " Good Timing: CEO Stock Option Awards and Company News Announcements," Journal of Finance, American Finance Association, vol. 52(2), pages 449-76, June.
    10. Michaely, Roni & Womack, Kent L, 1999. "Conflict of Interest and the Credibility of Underwriter Analyst Recommendations," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 653-86.
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    13. Eli Ofek & David Yermack, 2000. "Taking Stock: Equity-Based Compensation and the Evolution of Managerial Ownership," Journal of Finance, American Finance Association, vol. 55(3), pages 1367-1384, 06.
    14. Louis K. C. Chan & Jason Karceski & Josef Lakonishok, 2003. "Analysts' Conflict of Interest and Biases in Earnings Forecasts," NBER Working Papers 9544, National Bureau of Economic Research, Inc.
    15. Heinkel, Robert & Kraus, Alan, 1988. "Measuring Event Impacts in Thinly Traded Stocks," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 23(01), pages 71-88, March.
    16. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    17. Bowen, Robert M. & DuCharme, Larry & Shores, D., 1995. "Stakeholders' implicit claims and accounting method choice," Journal of Accounting and Economics, Elsevier, vol. 20(3), pages 255-295, December.
    18. Aboody, David & Kasznik, Ron, 2000. "CEO stock option awards and the timing of corporate voluntary disclosures," Journal of Accounting and Economics, Elsevier, vol. 29(1), pages 73-100, February.
    19. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
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