The Role of Executive Risk-Taking Incentives in Voluntary Disclosure Accuracy

Abstract

We investigate whether common compensation features can encourage managers to reveal more of their private information. Under the assumption that managers have private knowledge of their firms’ future earnings, we use management forecast accuracy to proxy for the extent to which managers reveal their private information and offer two main findings. First, both the amount of severance pay a manager receives and the convexity of their stock option portfolio (i.e., vega) are positively associated with that manager’s forecast accuracy. This suggests that if shareholders compensate managers in ways that reduce concerns over firm volatility, they are more forthcoming with their private information. Second, these contracting incentives are more strongly associated with forecast accuracy when short-term pressure to conceal private information is higher. Additional analyses suggest that (1) these results are unlikely explained by earnings management activity subsequent to the forecast, (2) managers with these contracting incentives issue less optimistically biased forecasts, and (3) these contracts increase forecast accuracy of both good and bad news. Overall, our results suggest compensation can encourage managers to provide more accurate disclosures, a clear benefit to capital market participants.