Earnings Warnings and CEO Welfare

47 Pages Posted: 10 Nov 2016

See all articles by Ping Wang

Ping Wang

Pace University - Lubin School of Business

Masako N. Darrough

Baruch College - CUNY

Linna Shi

University of Cincinnati - Lindner College of Business

Multiple version iconThere are 2 versions of this paper

Date Written: October/November 2016


Some CEOs decide voluntarily to issue a warning when they expect a negative earnings surprise. Prior research suggests that warnings contain incremental information beyond actual earnings; warning firms tend to experience permanent earnings decreases. This paper investigates whether compensation committees take warnings into account in setting CEO compensation. We find that warnings are significantly negatively (positively) associated with CEO bonus (option grants), suggesting that compensation committees adjust CEO compensation towards a more high‐powered structure after warnings. However, the sensitivity of bonus or option grants to earnings and stock returns is not affected except for bonus sensitivity to stock returns. We also find weak evidence of an increase in forced CEO turnover after warnings, accompanied by a significant increase in its sensitivity to stock returns. This benefits CEOs with higher ability but imposes more risk on other CEOs. These findings provide a partial explanation of why not every CEO facing a negative surprise decides to issue a warning. Our results are robust to various specifications. In particular, the impact of warnings on compensation appears invariant to the timing or the number of warnings. Overall, these findings suggest that the signal from warnings is used in determining CEO compensation and retention.

Keywords: management guidance, warnings, CEO compensation, CEO turnover

Suggested Citation

Wang, Ping and Darrough, Masako N. and Shi, Linna, Earnings Warnings and CEO Welfare (October/November 2016). Journal of Business Finance & Accounting, Vol. 43, Issue 9-10, pp. 1197-1243, 2016, Available at SSRN: https://ssrn.com/abstract=2867181 or http://dx.doi.org/10.1111/jbfa.12213

Ping Wang (Contact Author)

Pace University - Lubin School of Business ( email )

1 Pace Plaza
New York, NY 10038-1502
United States

Masako N. Darrough

Baruch College - CUNY ( email )

One Bernard Baruch Way
New York, NY 10010
United States
646 312 3183 (Phone)
646 312 3161 (Fax)

Linna Shi

University of Cincinnati - Lindner College of Business ( email )

P.O. Box 210211
Cincinnati, OH 45221-0211
United States
(513) 556-2097 (Phone)

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