Do Corporate Insiders Use External Signals in Performance Evaluation? Evidence on SEC Comment Letters

Abstract

Prior research shows that SEC comment letters provide useful information to outsiders of the firm. However, whether insiders such as boards of directors use SEC comment letters for the purpose of internal performance evaluation has not been studied. We find that firms reduce CEO annual bonuses after receiving SEC comment letters related to revenue recognition. We further document that this negative effect is stronger for high-growth firms, firms with less powerful CEOs and firms with higher non-transient institutional investors. The results are robust to using comment letter disclosure returns to measure their materialness and controlling for the endogeneity of receiving these letters. Overall, the evidence indicates that the board of directors incorporates the information provided in SEC comment letters in setting executive pay, suggesting that the board of directors adjusts the performance evaluation system ex post upon observing a negative non-financial signal triggered from the outside.

Keywords: SEC comment letters, executive compensation, government monitoring

JEL Classification: M41, M46, M48