Pessimistic Earnings Guidance Before Annual Incentive Plan Approval

58 Pages Posted: 14 Mar 2017  

Xiumin Martin

Washington University in Saint Louis - Olin School of Business

Hojun Seo

National University of Singapore - NUS Business School

Jun Yang

Indiana University - Kelley School of Business - Department of Finance

Date Written: March 11, 2017

Abstract

Corporate boards determine the performance metrics for CEOs’ annual incentive plans (AIPs) in compensation committee meetings at the beginning of each fiscal year. We provide evidence that management tends to issue pessimistic earnings guidance ahead of these meetings (“event-window guidance”), and that this pessimistic guidance leads analysts to lower their earnings forecasts, which commonly serve as an anchor for setting AIP performance goals. This pessimism in event-window earnings guidance is present when performance goals are linked to measures such as Earnings-Per-Share (EPS), but not when they are linked to revenue, providing further evidence that pessimistic event-window guidance is motivated by a desire to manipulate executive compensation. In the cross section, pessimistic event-window guidance is more pronounced when analyst forecasts are optimistic, when the EPS performance target was missed in the previous year, when the target payout amount is large, or when shareholders actively monitor the firm. Lastly, pessimism in event-window guidance is associated with higher bonus payouts. Overall, our study sheds light on the strategic role of management disclosure policy in the executive compensation 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, Pessimistic Earnings Guidance Before Annual Incentive Plan Approval (March 11, 2017). Kelley School of Business Research Paper No. 17-19. 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 - NUS Business School ( 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)

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