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Review of Quantitative Finance and Accounting

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15-03-2018 | Original Research

CEO power, board oversight, and earnings announcement tone

Authors: D. G. DeBoskey, Yan Luo, Linying Zhou

Published in: Review of Quantitative Finance and Accounting | Issue 2/2019

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This study constructs a model of the determinants of earnings announcement tone in order to examine the impact of CEO power on earnings announcement tone. An interaction term between CEO power and board monitoring is used to test whether effective board oversight moderates the strength of the association between CEO power and earnings announcement tone. Following prior research, we measure earnings announcement tone as the spread in the proportion of positive and negative words in the announcements. CEO power is assessed across two dimensions: (1) expert power (CEO tenure) and (2) structural power (CEO-chairman duality). We use board independence, meeting frequency, and board meeting attendance to measure the effectiveness of board oversight. We find that earnings announcement tone is significantly positively associated with CEO tenure and CEO duality. The effect of CEO tenure is weaker when board oversight is stronger, especially when board members have higher reputation costs, whereas the effect of CEO duality is unchanged by board oversight mechanisms. The empirical evidence is broadly consistent with the notion that powerful CEOs use a more optimistic and aggressive tone in their earnings’ announcements and that stronger board oversight is effective in constraining overt aggressiveness in the earnings announcements issued by CEOs with longer tenure but not those issued by dual-role CEOs. The results are robust to several sensitivity tests. Finally, this study identifies CEO power and board oversight as previously unrecognized determinants of tone in earnings announcements.

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CEO/CFO connectedness through the appointment process increases the likelihood of corporate fraudulent activity (Khanna et al. 2015). Executives recruited and hired by a CEO are likely to share the CEO’s goals, will be loyal to the CEO, and are less independent (Landier et al. 2012).

CEOs occupy more powerful positions than CFOs and, as a result, have the ability to influence the compensation, job security, future career opportunism, and financial decisions of their CFOs (Feng et al. 2011; Mian 2001).

Audit committees are specifically charged with the responsibility and power to oversee a firm’s financial reporting and further its objectivity (SOX 301). This study focuses on board characteristics rather than audit committee characteristics for two reasons. First, the sample covers the post-SOX period and SOX mandates that each member of the audit committee of a listed company must be independent (SOX 301), resulting in a lack of variance between observations. Second, Beasley and Salterio (2001) suggest that the board`s direct control over audit committee membership can directly affect the ability of the audit committee to monitor management’s financial reporting process. In this study, board effectiveness is used to proxy for audit committee oversight effectiveness.

This study also calculates the variance inflation factor (VIF) in order to address the concern of multicollinearity. Commonly, a VIF above 10 is considered to indicate strong multicollinearity. The biggest VIF among the variables in this regression is 2.88. We therefore conclude that these results are not affected by multicollinearity.

The biggest VIF among the variables in this regression is 2.75, suggesting that the results are not affected by multicollinearity.

The results of board independence in Panels A and B in Table 6 suggest that board independence is positively associated with earnings announcement tone. This is consistent with prior studies demonstrating that non-independent (inside) directors are an important source of firm-specific information, and their inclusion on the board can lead to more effective decision-making and monitoring (Fama and Jensen 1983), such as higher firm value (Coles et al. 2008; Rosenstein and Wyatt 1997) and more precise management forecasts (Karamanou and Vafeas 2005). Following this line of reasoning, the positive association between board independence and tone in this study suggests that independent directors are less effective in constraining a positive tone in the earnings announcement because they do not know the operational environment (industry, supply chain, competition) or forecasts of future performance well enough to challenge the tone of management’s earnings announcement.

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Title: CEO power, board oversight, and earnings announcement tone
Authors: D. G. DeBoskey
Yan Luo
Linying Zhou
Publication date: 15-03-2018
Publisher: Springer US
Published in: Review of Quantitative Finance and Accounting / Issue 2/2019
Print ISSN: 0924-865X
Electronic ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-018-0721-x

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