Target Performance Goals in CEO Compensation Contracts and Management Earnings Guidance

63 Pages Posted: 14 Mar 2017 Last revised: 6 Sep 2018

See all articles by Xiumin Martin

Xiumin Martin

Washington University in Saint Louis - Olin School of Business

Hojun Seo

National University of Singapore

Jun Yang

Indiana University - Kelley School of Business - Department of Finance

Daniel Sungyeon Kim

Peking University HSBC Business School

Date Written: March 11, 2017

Abstract

We study how compensation committees set CEOs’ earnings performance goals in annual incentive plans (AIPs) and their implications for managers’ strategic earning guidance behavior. We find corporate boards rely on earnings forecasts provided by both financial analysts and managers in setting performance goals. Also, the weight boards place on a manager’s earnings forecasts increases with managers’ information advantage over analysts. We next examine the implications of this process for management earnings guidance. We find that the forecasts issued by management ahead of compensation committee meetings (“event-window guidance”) are more pessimistic than those issued at other times. This pessimism in event-window earnings guidance is present when performance goals are linked to earnings-based measures such as Earnings-Per-Share (EPS), but not when they are linked to revenue, suggesting that pessimistic event-window guidance is likely motivated by a desire to depress earnings performance goals. Furthermore, pessimism in event-window guidance is associated with higher bonus payouts as well as total payouts to CEOs. Lastly, meeting or beating performance goals significantly reduces the likelihood of forced CEO turnover. Overall, this study provides insights into the process of setting managerial performance goals and management’s strategic disclosure behavior arising from this process.

Keywords: Annual Incentive Plan (bonus contracts), Performance Targets, Management Earnings Guidance

JEL Classification: G34, M41, M52

Suggested Citation

Martin, Xiumin and Seo, Hojun and Yang, Jun and Kim, Daniel Sungyeon, Target Performance Goals in CEO Compensation Contracts and Management Earnings Guidance (March 11, 2017). Kelley School of Business Research Paper No. 17-19; 28th Annual Conference on Financial Economics and Accounting. Available at SSRN: https://ssrn.com/abstract=2931372 or http://dx.doi.org/10.2139/ssrn.2931372

Xiumin Martin

Washington University in Saint Louis - Olin School of Business ( email )

Saint Louis, MO 63130
United States

Hojun Seo (Contact Author)

National University of Singapore ( email )

15 Kent Ridge Drive, Singapore 119245

Jun Yang

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3395 (Phone)
812-855-5875 (Fax)

Daniel Sungyeon Kim

Peking University HSBC Business School ( email )

University Town
Shenzhen, Nanshan District 518055
China

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