Executive Compensation and Analyst Guidance: The Link Between CEO Compensation and Expectations Management

Abstract

During the last decade, a surprisingly high percentage of U.S. companies has fulfilled or beaten analysts' earnings per share forecasts. One of the most frequently cited reasons for this growing tendency is a change in the nature of U.S. executive compensation structure. As stock options have become an increasingly important part of executive compensation, the preservation or enhancement of short term stock value around the earnings announcement has become a priority for managers. Besides earnings management, a widespread way to meet analyst expectations is to inject pessimism into their forecasts by providing analysts with negative clues, or so-called downward guidance. This paper is the first to investigate the relationship between the practice of analyst guidance and executive compensation packages. We document a strong link between expectations management and the relevant options component of CEO compensation, bonus plans, and the percentage of the company's shares owned by the CEO who manages it. In a second set of tests, we show that firms which meet or beat analyst forecasts at the earnings announcement generate positive abnormal returns, which are significantly lower for firms suspected of managing expectations.

Keywords: Analyst guidance, Earnings surprise, Executive compensation, Stock options