The Use of Analyst Forecasts in the Target Setting of Executive Annual Bonus Contracts

Abstract

Prior research in managerial accounting has documented that external information, such as peer performance, is typically used in target setting. However, there is only limited evidence of what specific information is actually used in this process. This study examines how analysts’ annual earnings forecasts influence target setting for executives’ bonus contracts. We provide novel evidence that analyst forecasts are positively associated with firms’ bonus target revisions. Furthermore, the use of analyst forecasts in target setting is less pronounced when the forecasts are noisier, and it is more prominent when analysts have an informational advantage over managers. Finally, the results from additional analyses are not consistent with alternative explanations that both bonus target revisions and analyst forecasts are influenced by internal planning information or that analyst forecasts are influenced by bonus target revisions (i.e., reverse causality).

Keywords: Executive compensation; annual bonuses; analyst forecasts; performance targets