Management Accounting Section Midyear Meeting

CEOs Under Dismissal Threat: The Case of Setting Stretch Earnings Guidance

• In Event: CEO Compensation

Abstract

This study examines earnings guidance set by CEOs under dismissal threat. Prior relative performance evaluation studies document that CEOs tend to be dismissed because the board of directors does not filter out uncontrollable common shocks when making CEO turnover decisions. In such cases, we find that CEOs respond to the threat by setting stretch earnings guidance, i.e., aggressive and difficult-to-achieve earnings forecasts to delay or avoid their replacement. Setting stretch earnings guidance is shown to be effective in delaying CEO turnover. Notably, further evidence partially suggests strategic behavior in announcing stretch earnings guidance resulting in a tendency to miss it. The findings extend the management earnings forecasts literature by highlighting a compelling setting, in which self-interested CEOs set stretch earnings guidance to delay their replacement and mislead the board of directors. The findings contribute to expanding our understanding of CEO replacement decisions, which is one of the most important decisions made by the board of directors. Particularly, we extend the relative performance evaluation and CEO turnover literature by demonstrating that CEOs comprehend the threat of being replaced when industry-level performance is bad and take action to suspend their turnover.

Authors

• Doron Hadass, Tel Aviv University

• Dan Weiss, Tel Aviv University