Compensation Committee Meeting and Management Earnings Guidance

• In Event: Management Forecasts and Voluntary Disclosure

Abstract

Corporate boards determine performance targets for CEOs’ annual bonus plans at compensation committee meetings at the beginning of a fiscal year. We study whether CEOs have incentives to issue downward-biased earnings guidance right before these meetings. We find that management earnings guidance issued immediately before the meetings tends to be lower than the prevailing analyst earnings consensus forecasts relative to management earnings guidance issued outside this window. This downward bias is only present when the performance target is linked to earnings per share. We do not observe the downward bias when revenue serves as the performance target. In addition, the downward-biased management earnings guidance prior to compensation committee meetings is more pronounced when the prevailing analyst earnings consensus is much higher than the firm’s actual target EPS, projected target EPS or the actual EPS in the current period. We also observe stronger downward-biased management earnings guidance prior to compensation committee meetings when institutional ownership is more concentrated or when the CEO serves as a chairman of the board. Lastly, we find that analysts downwardly revise their earnings forecasts after observing management earnings guidance, which is issued before the compensation committee meetings. Taken together, our findings suggest that managers have incentives to issue pessimistic earnings guidance before compensation committee meetings and that analyst earnings forecasts might serve as an anchor for the compensation committee to defend its choice of the target performance metric under shareholder pressures.

Authors

• Hojun Seo, Washington University in St. Louis

• Xiumin Martin, Washington Univ in Saint Louis

• Jun Yang, Indiana University