Earnings Warnings and CEO Welfare

• In Event: Shareholder Rights, Corporate Boards and Compensation

Abstract

Some CEOs decide to voluntarily issue a warning when they expect a negative earnings surprise. Prior research suggests that warnings have incremental information beyond actual earnings; warning firms tend to experience permanent earnings decreases. This paper investigates whether boards of directors consider the issuance of warnings in setting CEO compensation. We find that while warnings do not affect total compensation, they are significantly negatively (positively) associated with CEO bonus (option grants). This suggests that boards of directors adjust CEO compensation towards a more incentive-based, future-oriented structure after warnings. However, the sensitivity of bonus or option grants to earnings and stock returns is not affected. We also find that issuing warnings reduces the likelihood of CEOs being forced out in the future, which may explain how CEOs benefit from issuing warnings. Overall, these findings suggest that the signal from warnings is used in determining CEO compensation and job retention.

Authors

• Ping Wang, Pace University

• Masako Darrough, CUNY-Baruch College