A Dark Side of Industry Tournament Incentives

Abstract

Are firms’ financial disclosure decisions affected by executive compensation at other firms? We find that a CEO’s pay gap relative to the highest CEO pay among industry peers, defined as industry tournament incentives, can lead to distortions in corporate financial disclosures. Our analyses show that controlling for CEO-firm pair fixed effects, firms run by CEOs with stronger industry tournament incentives engage in more earnings manipulation, measured by a higher propensity to meet or narrowly beat consensus earnings forecasts, larger abnormal accruals, and a higher probability of committing financial misrepresentation and restating earnings. The evidence is concentrated in cases where ex ante CEOs are more likely to participate in the industry tournament, and where agency problems are more severe. Conditional on firm performance, CEOs with stronger industry tournament incentives also disclose positive (negative) news more (less) frequently. Our findings imply that industry tournaments can create perverse managerial incentives in corporate disclosure decisions, and that one firm’s executive compensation policy can generate negative externality for other firms’ disclosure practice.

Keywords: Industry tournament incentives, managerial labor market, financial disclosure, benchmark beating, earnings management

JEL Classification: G30, J31, J33, J44, M41