An Examination of the Accuracy and Usefulness of Management Earnings Guidance Around Stock Option Grants

Abstract:     
This paper examines the effect of managerial stock option incentives on the accuracy and information content of firms' voluntary earnings guidance. Prior research suggests that managers manipulate earnings downwards before receiving stock option awards to increase the value of their grants. Similar incentives could lead managers to distort earnings guidance around stock option grants, but the effect of option incentives on the timeliness and usefulness of earnings guidance has received little attention. We show that managers provide more pessimistic guidance before stock option awards than afterwards, consistent with manipulation. However, pre-grant guidance improves upon existing consensus earnings forecasts and is similar to post-grant guidance in bias and accuracy, suggesting that option incentives do not lead managers to distort pre-grant guidance. Furthermore, investors and analysts react similarly to pre- versus post-grant guidance, suggesting that market participants view these two types of guidance as equally informative. Finally, firms that award stock options provide more frequent guidance and have lower absolute analyst forecast errors than other firms, consistent with stock options increasing managerial incentives to disclose information about earnings. Overall, our study indicates that although stock option plans may induce selective disclosure consistent with managers' self-interest, they contribute to an improved overall information environment for the firm.

Keywords: Management disclosures, stock options, agency theory, analyst forecasts, information environment

JEL Classifications: G29, M14, M41, M43, M45, M52, K22, J33, G34

Working Paper Series