Pessimistic Earnings Guidance before Annual Incentive Plan Approval

• In Event: Voluntary Disclosure - Determinants and Effects

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 (“eventwindow
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.

Authors

• Xiumin Martin, Washington University in St Louis

• Hojun Seo, National University of Singapore

• Jun Yang, Indiana University