Managerial Incentives, Disclosure, and Disclosure Substitution: Evidence from Relative Performance Evaluation

Abstract

We examine the relation between managerial incentives and disclosure. Specifically, we examine how contracts that explicitly evaluate managers relative to peer performance are associated with: (1) the transparency of mandatory disclosure; (2) the provision of voluntary disclosure; and (3) the substitution between the two. We find a negative relation between relative performance plans in which competition with peers is strong and both the transparency of mandatory disclosure and the provision of voluntary disclosure. Moreover—and consistent with our theoretical prediction—we show that the substitution between the two depends critically on whether managers compete with peers for market prices or accounting numbers. We further show that boards’ contract-design choices for these incentive plans are consistent with proprietary cost considerations. Collectively, our findings suggest that managerial incentives can motivate managers to abandon the novel “disclosure substitution” strategy.

Keywords: proprietary costs, information disclosure, relative performance evaluation, strategic interaction, capital markets

JEL Classification: D22, D82, J33, L1, M12, M48