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Review of Quantitative Finance and Accounting

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01.07.2013 | Original Research

CEO bonus compensation: the effects of missing analysts’ revenue forecasts

verfasst von: Christopher T. Edmonds, Ryan D. Leece, John J. Maher

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 1/2013

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Abstract

We investigate the incremental contract relevance of analysts’ revenue forecasts while controlling for earnings forecasts and find CEOs receive smaller bonuses when missing analysts’ annual and quarterly revenue expectations. Our results support the link between the value relevance of the revenue performance measure and the contract relevance of that measure. Further, we find revenue forecasts to be more contract relevant for CEOs of firms with high growth expectations, consistent with Rees and Sivaramakrishnan’s Contemp Acc Res 24(1):259–290, (2007) findings that growth firms receive a larger market penalty for missing revenue targets. Overall, our findings provide empirical support for the conjecture that compensation committees rely on information consistent with that conveyed in analysts’ revenue forecasts when contracting with management.

Vorheriger Artikel Does tax convexity matter for risk? A dynamic study of tax asymmetry and equity beta

Nächster Artikel Recap of the 23rd annual financial economics and accounting conference, November 16–17, 2012

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For example, under the Dodd Frank Wall Street Reform and Consumer Protection Act, public firms are required to implement procedures to “claw back” compensation in the wake of improper financial accounting application (US Senate 2010).

ErtimurY and Martikainen (2003) document a dramatic increase in the number of revenue forecasts.

The amount of financial information disclosed within firms’ earnings announcement press releases has substantially increased over time (Francis et al. 2002). Press releases now include a revenue announcement as well as other information such as detailed financial statements, current operating data, and nonrecurring items. Francis et al. (2002) find that the disaggregated earnings components now being provided voluntarily by management have increased the usefulness of press releases to investors.

Examples of major accounting scandals during this period include Enron, WorldCom, Adelphia, HealthSouth, McKesson, Tyco, and Qwest.

The analysts’ last median consensus forecast as of the first 90 days of the fiscal year are used in our annual analysis and the last median consensus forecast of each quarter is used in the quarter analysis.

IRS Code Section 162(m) was passed by Congress in 1993 to limit the tax deductibility of non-performance based compensation.

There is also a logical argument for setting the target during this time in that the compensation committee must set performance targets in a reasonable time-frame to allow an executive the opportunity to achieve the target(s). Executives do not have much opportunity to change performance to meet expectations that were set during the fourth quarter.

See Janakiraman et al. 1992; Clinch and Magliolo 1993; Dechow et al. 1994; Baber et al. 1998; Gaver and Gaver 1998; Baber et al. 1999.

A detailed description of all the variables in Eqs. (1), (2), and (3) is available in the Appendix of the paper.

The base state is held out of the regression. The base state is where an observation meets all four EPS or revenue forecasts, respectively.

To be consistent with Matsunaga and Park (2001) we do not include the other control variables utilized in Eq. (1); however, all inferences are identical if all control variables listed in Eq. (1) are also included in Eq. (2).

Only a very limited number of revenue forecasts are available on IBES prior to 1998. Revenue forecasts became available on IBES in 1996. All inferences remain the same if the sample is expanded to include the 1996 and 1997 observations. Because 2009 actual earnings and revenue numbers are not available on IBES until mid-2010 our sample includes few 2009 observations.

Results are qualitatively similar if variables are Winsorized at the 1st and 99th percentile, or if only ΔBONUS and ΔROA are trimmed/Winsorized, or if extreme observations are left in the sample.

Fama and French (1997) 48 industry classifications are used to exclude Utility and Financial companies.

The mean (median) total compensation is $5,525,219 ($3,094,045). Total compensation includes the total value of restricted stock granted, total value of stock options granted (using Black–Scholes), long-term incentive payouts and all other compensation.

IRS Code Section 162(m) allows firms to deduct performance-based compensation in excess of the $1 million total compensation limit per executive if certain criteria are met. One of which is to establish performance targets within the first 90 days of the fiscal year. Performance-based means compensation must be tied to specific performance targets. Performance-based compensation includes long- and short-term cash bonuses, and stock options.

Another perspective put forth by Cadman et al. (2010) provides additional insight as to why our sample consists of fewer firms that miss (on average) analysts’ consensus EPS and/or revenue forecasts. Cadman et al. (2010) show EXECUCOMP firms incorporate more aggregate financial measures (e.g., EPS, revenue, cash flow from operations) into cash compensation contracts. As such, EXECUCOMP firm CEOs have additional incentives to avoid missing analysts’ EPS and revenue forecasts over non-EXECUCOMP CEOs.

Inferences remain the same if we compare squared forecasts errors.

Our quarterly sample consisted of 5,487 firm year observations and 21,951 (5,487 * 4) quarterly earnings and sales forecasts. We utilized all 21,951 forecasts in conducting the comparison displayed in Table 4, Panel B.

In untabulated robustness tests, we also investigate the effect of missing last year’s (quarter’s) revenue on CEO bonus compensation. Our results indicate this target is not significant in explaining CEO bonus compensation.

As an additional analysis, we also investigated whether an asymmetric reaction exists between the penalty for missing revenue forecasts and the premium for beating revenue forecasts. Untabulated results show no significant differences between the absolute value of the bonus penalty and the bonus premium, and thus provide no support for the existence of an asymmetric reaction.

The resulting slope shift for the top growth decile (GROWTH = 9) and missed revenue forecast is 0.0498 + (−0.0288 × 9) = −0.2094 or a 20.94 percent decrease in the bonus change as a percentage of salary for the CEO.

Table 6, Panel B, shows that the bonus penalty for firms missing revenue forecasts in the lowest growth decile is not significantly different from zero (β₁ coefficient is 0.0499 with a t-statistic of 1.38).

In an untabulated analysis, we tested for significant differences between the MISS_REV and MISS_EPS coefficients within different deciles of expected growth. We were unable to detect a statistically significant difference between the two coefficients in any of the expected growth deciles.

In an untabulated analysis we replicated the Matsunaga and Park (2001) study over their sample period, 1993–1997. Results were very similar.

Consensus forecasts as of the first 90 days of the fiscal year are used in the sensitivity analysis.

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Titel: CEO bonus compensation: the effects of missing analysts’ revenue forecasts
verfasst von: Christopher T. Edmonds
Ryan D. Leece
John J. Maher
Publikationsdatum: 01.07.2013
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 1/2013
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-012-0305-0

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