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Review of Quantitative Finance and Accounting

Erschienen in:

01.05.2013 | Original Research

CEO incentives and earnings prediction

verfasst von: James Jianxin Gong, Siyi Li

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 4/2013

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Abstract

This study investigates whether information about Chief Executive Officer (CEO) incentives is useful for predicting future earnings. We find that in companies with higher CEO equity incentives, current year earnings are more informative of future earnings than in other companies. Additionally, in an earnings prediction setting, CEO incentives are shown to provide information about future earnings that is incremental to current earnings or earnings components. The predictive power of CEO incentives for future earnings is robust to the inclusion of other predictors of future earnings. Furthermore, we find that CEO incentives are predictive of “real” future earnings, as represented by operating cash flow and non-discretionary accruals, but not predictive of future discretionary accruals. Finally, we find that financial analysts do not incorporate information about CEO incentives when they forecast future earnings. This result suggests that incorporating CEO incentives can potentially improve analyst forecasts of future earnings.

Vorheriger Artikel Can rating agencies look through the cycle?

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Requiring the availability of analyst EPS forecast data reduces the sample size by about 10%, as the base sample includes S&P 1500 firms. When we ease the requirement and repeat the main analysis, the results are almost identical.

The apparent non-linearity is intriguing, though it does not directly bear on our examination of the incremental predictive power of CEO incentives. One conjecture is as follows. As incentives are provided in response to agency problems, low incentives may reflect lack of serious agency problems at the firm, while high incentives may have effectively mitigated agency problems, which lead to higher earnings persistence in both scenarios. For firms with incentives ranked in the middle, it is not clear if incentives are effective in fully mitigating agency problems.

Dichev and Tang (2009) demonstrate the informativeness of earnings volatility for future earnings. When we include only earnings volatility to the base earnings prediction model, we find similar results in that earnings volatility is significantly negatively related to future earnings negatively. The incremental R² from adding the earnings volatility variable alone in a simple earnings prediction model is similar to our results on CEO incentives. The earnings volatility variable, however, is not significant in the model when we include additional control variables, as in Table 7.

When using cash flow from operations and accruals, the test on the incremental informativeness of CEO incentives on analyst forecast of one-year-ahead earnings is similar to that of Bradshaw, Richardson, and Sloan (2001). The findings are also similar—compared with the results in Table 10, it appears that the relative weight on accruals is too high, indicating analysts’ overweighting the implications of accruals for future earnings.

The results with regard to information in accruals appear not to be entirely consistent with the findings of Bradshaw, Richardson, and Sloan (2001). Two possible reasons are: first, our sample differs from theirs in that we only include S&P 1500 firms; and second, our EPS forecast is taken as of the sixth month after fiscal year end. As Bradshaw, Richardson, and Sloan (2001) show, the weighting on accruals in analyst forecasts changes as time goes by.

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Titel: CEO incentives and earnings prediction
verfasst von: James Jianxin Gong
Siyi Li
Publikationsdatum: 01.05.2013
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 4/2013
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-012-0291-2

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