Board interlocks and the diffusion of disclosure policy

Disclosure policy also may spread across firms through public channels instead of social networks. Houston et al. (2010) find that, of 222 stoppers over 2002–2005, only 26 firms (11.7 %) publicly announce their policy changes. Because only a few guidance stoppers publicly announce and rationalize their decision to stop providing quarterly guidance and the majority just cease to provide guidance, we believe that information spillover through public channels cannot explain our results. In addition, we find that director-specific experience from prior cessation is important for disclosure policy contagion, which cannot be explained by spillover through public channels. Our results are robust to the exclusion of firms whose board members are connected to previous stoppers that publicly announce their guidance cessation decisions. The results are also robust to controlling for the potential ripple effect of the widely publicized Coca-Cola’s guidance cessation announcement on December 13, 2002.

Similarly, in their study of earnings management contagion, Chiu et al. (2013) argue that “an interlocked director observing earnings management in another firm may estimate a lower perceived cost of manipulation and a higher perceived benefit, potentially leading to rational herd behavior or information cascades.”

In October 2000, the US Securities and Exchange Commission (SEC) adopted Reg FD, which mandates that all publicly traded companies must disclose material information to all investors at the same time. Prior to Reg FD, managers often provided guidance to financial analysts and institutional investors through private channels. Wang (2007) provides evidence that, in the pre-Reg FD period, firms with higher proprietary information costs and more predictable earnings are more likely to provide private earnings guidance. Such firms might stop providing public guidance but continue to provide private guidance. Because we cannot observe private guidance, we cannot distinguish guidance cessation from replacing public guidance with private guidance, and therefore we cannot reliably identify guidance cessation in the pre-FD period. In addition, Reg FD changes the information environment. When firms’ strategy for voluntary disclosure is fundamentally different between pre- and post-FD periods, applying director learning in the pre-FD period to the post-FD period is difficult. Therefore we follow Houston et al. (2010) and Chen et al. (2011) and focus on the post-Reg FD period to ensure that our sample firms have truly stopped providing quarterly earnings guidance.

Much of the debate centers on quarterly guidance that may motivate managers to engage in myopic behavior. Houston et al. (2010) and Chen et al. (2011) show that firms stop providing quarterly guidance, but not necessarily annual guidance, as a response to the call from critics.

We search for the history of earnings or revenue guidance for all stoppers from a year before to a year after the event quarter. We search by keywords in the full texts of Business Wire, PR Newswire, Associated Press Newswires, and Reuters Significant Developments. The phrases used include two sets of keywords: (1) guidance, outlook, see(s), expect(s), expectation, forecast(s), project(s), estimate(s), higher, and lower; and (2) net, earnings, income, results, loss, gain, profit(s), improvement, better, performance, revenue(s), and sales. All keywords, except guidance, outlook, and expectation, are used in Kim et al. (2008).

While the earliest stopper quarters are evenly distributed across sample years, the earliest maintainer quarters are concentrated in earlier sample years. To better match the time-series distribution of sample and control firm quarters, we randomly draw maintainer quarters. Our results are robust if we use the earliest quarter of maintainers.

Our Interlock measure is similar to the PE Interlock measure in Stuart and Yim (2010), who examine the role of board interlocks in change-in-control transactions in the private equity industry. The difference is that they use a five-year window in defining interlocks, while we use a two-year window. We choose a shorter window in defining interlocks because of our shorter sample period. As a robustness check, we also try a three-year window, and our results are qualitatively and quantitatively similar.

Our control variables closely follow those in Chen et al. (2011). Our results are qualitatively and quantitatively similar if we instead control for the same set of variables in Houston et al. (2010).

As a robustness check, we also use public pension funds as a proxy for long-term investors because pension funds tend to have longer investment horizons and often monitor firms more actively than other investors (Smith 1996; Gillan and Starks 2000; Gompers and Metrick 2001; Qiu 2006; Cronqvist and Fahlenbrach 2009). Our results are qualitatively and quantitatively similar with this alternative proxy.

For more information about this litigation risk model, see Johnson et al. (2001); Rogers and Stocken (2005); Houston et al. (2010), Appendix 2.

We also investigate whether our results are concentrated among firms with poor performance. We add the interaction of BHRET and Interlock to our baseline regression. The marginal effect of Interlock remains positive and statistically significant after including the interaction term. In addition, the positive relation between Interlock and quarterly earnings guidance cessation is not more pronounced for poorly performing firms. If anything, the interlock effect is more pronounced for better performing firms, suggesting that poor performance is unlikely to explain the director interlock effect.

By definition, each of our director-specific experience variables takes the value of zero for all firms with no directors interlocked to previous stoppers. The variation of these variables comes from firms with stopper-interlocked directors. The interactions of director-specific experience variables and Interlock are therefore the same as the director-specific experience variables themselves. For example, the interaction of Positive Δ(forecast dispersion) and Interlock is the same as that of Positive Δ(forecast dispersion) itself. The same applies to the variables Tenure ≤ 2 years and Migrated director in Table 7.

We also try excess stock returns of a previous stopper in the year in which it stops issuing guidance, as an alternative proxy for negative experience for interlocked directors. Specifically, we calculate market-adjusted returns and industry-adjusted returns as well as changes of these returns from the pre-event period. We then include a negative-excess-return indicator as well as the interaction of this indicator and Interlock in the regressions. Untabulated results show an insignificant coefficient on the interaction of Interlock and each negative excess return indicator. This insignificant result is likely due to long-run returns being a noisy proxy for interlocked directors’ experience at the previous stopper because of confounding events during the return measurement period.

We also re-estimate our probit regressions by replacing the Interlock indicator with the natural logarithm of (1 + number of interlocked stopping firms) or the natural logarithm of (1 + number of stopper-interlocked directors). Untabulated results show positive and statistically significant marginal effects of alternative stopper interlock variables, consistent with the results in Table 3.

Following Reichelt and Wang (2010), we first identify the city of each auditor from Audit Analytics and categorize it by MSA to define same-office auditors.

The number of observtions with Left Director = 1 is 113. Therefore lack of power is unlikely the cause for the insignificant marginal effect of Left Director.

Some stakeholders of the firm (e.g., financial analysts) may oppose stopping quarterly earnings guidance. To solidify the argument, managers may seek to appoint directors with guidance cessation experience.

The results utilizing a control sample of firms that issue quarterly earnings guidance in at least three out of the four quarters both in the pre- and post-event periods are similar.