Do Managers Respond to the Divergence between Debtholders and Shareholders? Evidence from Equity Analyst-Based Benchmark Beating

Abstract

We examine managers’ responses to the divergent emphases of debtholders and shareholders as evidenced in analyst-based benchmark beating behavior. Using both levels and changes in the composition of debt and equity, we find that firms with high debt-to-equity intensity are less likely to meet or beat analyst-based earnings benchmarks. We also find that managers of high debt-to-equity firms that achieve analyst earnings targets are less likely to use accruals earnings management. In additional tests, we report that equity investors are less sensitive to earnings surprises of firms with high-debt reliance than those with low-debt reliance. In supplemental tests using debt covenant violations as a shock to right transfer between shareholders and creditors, we find additional support for the significant role of capital mix in equity benchmark beating. Overall, our evidence suggests that debt vs. equity intensity in capital structure is an important factor shaping firms’ analyst benchmark beating incentives.

Keywords: Capital structure, Analyst forecasts, Benchmark beating, Earnings Management