CEO stock option awards and the timing of corporate voluntary disclosures

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Abstract

We investigate whether CEOs manage the timing of their voluntary disclosures around stock option awards. We conjecture that CEOs manage investors’ expectations around award dates by delaying good news and rushing forward bad news. For a sample of 2,039 CEO option awards by 572 firms with fixed award schedules, we document changes in share prices and analyst earnings forecasts around option awards that are consistent with our conjecture. We also provide more direct evidence based on management earnings forecasts issued prior to award dates. Our findings suggest that CEOs make opportunistic voluntary disclosure decisions that maximize their stock option compensation.

Introduction

This paper investigates whether CEOs manage investors’ expectations around stock option awards. Because stock options are typically granted with a fixed exercise price equal to the stock price on the award date, we hypothesize that CEOs opportunistically manage the timing of their information disclosures to increase the value of their awards. In particular, we conjecture that they delay announcements of good news and rush forward bad news. Such a disclosure strategy ensures that decreases in the firm's stock price related to the arrival of bad news occur before, rather than after, the award date, while stock price increases related to the arrival of good news occur after, rather than before, the award.1

Using information from ExecuComp and handcollected data from annual proxy statements, we infer the dates of 4,426 stock option awards made between 1992 and 1996 to the CEOs of 1,264 firms. We document that many firms have a fixed schedule for awarding options to their CEOs; about half the firms, 572 firms with 2,039 awards, have award dates that are nearly identical every year. Using this sample of firms with fixed award schedules, we test our prediction that CEOs manage the timing of their disclosures around award dates.2 Focusing on scheduled awards allows us to mitigate the possibility that our findings are attributable to opportunistic timing of awards around company news announcements.

We conduct several tests to investigate whether CEOs manage investors’ expectations downward prior to scheduled awards. Our first test investigates changes in the distributional properties of analysts’ earnings forecasts. Prior evidence suggests that analyst forecasts largely reflect guidance provided by management through a variety of channels. Therefore, we investigate whether forecasts issued shortly before scheduled CEO option awards are abnormally low. To do that, we estimate the empirical distribution of analyst forecast errors for our sample firms over the 1992–1996 period. Consistent with our prediction, we find that forecasts issued during the three months prior to scheduled awards are significantly less optimistically biased than forecasts issued for the same firms during other months. This association is robust to controlling for variables which prior research suggests are associated with forecast errors, and to various specification checks. Our second test focuses on share price movements around award dates. Consistent with our prediction that CEOs manage investors’ expectations around option awards, we find a significant difference between the pre- and post-award periods; scheduled awards are preceded by insignificantly negative abnormal returns and followed by significantly positive abnormal returns.

Our third set of tests identifies cross-sectional variation with respect to CEOs’ incentives to manage investors’ expectations around scheduled awards. In particular, we focus on a subsample of scheduled awards made within just a few days of earnings announcements. Because managers likely have more private information shortly before earnings announcements than shortly thereafter, we conjecture that CEOs who receive their options immediately before earnings announcements have greater opportunities to adopt a voluntary disclosure strategy that maximizes the value of their awards. Specifically, we predict that these CEOs are more inclined to voluntarily preempt negative earnings surprises, and are less inclined to preempt positive surprises. Such a disclosure strategy increases the likelihood that stock price decreases related to the arrival of bad news occur before the award, and that stock price increases related to the arrival of good news occur after the award. We presume a similar strategy is less beneficial to CEOs who receive their options only after earnings are announced.3

Consistent with our prediction, we find that firms with scheduled awards before earnings announcements have, on average, significantly negative abnormal returns over the three month period prior to earnings announcement, and significantly positive abnormal returns at the earnings announcement date. The abnormal returns for these firms are significantly lower in the pre-earnings-announcement period, and significantly higher at the earnings announcement date, than the abnormal returns for firms with scheduled awards after earnings announcements. These findings are robust to controlling for the size and magnitude of the earnings surprise. We complement the market-based findings with evidence from management earnings forecasts issued by these firms during the pre-earnings-announcement period. We find that CEOs who receive their options before the earnings announcement are significantly more likely to issue bad news forecasts, and less likely to issue good news forecasts, than are CEOs who receive their awards after the earnings announcement. These findings are consistent with opportunistic timing of management voluntary disclosures around scheduled awards.

There is relatively little research on managers’ self-interested behavior in response to the structure of their stock option compensation. Most closely related to our study is Yermack (1997) who documents that CEO option awards are preceded, on average, by insignificantly negative abnormal returns, and are followed by significantly positive abnormal returns. Yermack interprets the stock price movements around option awards as evidence that managers influence their firms’ compensation committee to award them options in advance of favorable earnings announcements. Although our study is similar to Yermack's in that we also expect differences in news announcements before and after award dates, our hypotheses and research design are substantially different. Most notably, Yermack's hypothesis of an opportunistic timing of awards can only apply to companies that do not award options on a fixed schedule, and is not applicable to the many companies with scheduled awards, the focus of our study.

Another major distinction between the two studies relates to types of disclosures examined. Yermack (1997) focuses on earnings announcements, and predicts that options are more likely to be awarded before (after) positive (negative) earnings surprises. A maintained assumption underlying his analysis is that firms’ disclosures are exogenous, primarily in the form of periodic earnings announcements. In contrast, we incorporate the notion that managers use voluntary disclosures in press releases and in discussions with security analysts to effectively determine the timing of information releases. Our approach is motivated by our desire to investigate whether CEO option awards affect the timing of firms’ voluntary disclosures. Focusing on firms with scheduled awards permits us to distinguish between opportunistic timing of voluntary disclosures around award dates and opportunistic timing of awards around news announcements. Compensation consultants often argue that CEOs’ opportunistic behavior with respect to stock option compensation could be eliminated by requiring that options be awarded on a fixed schedule. However, we document that although many firms have a fixed award schedule, CEOs of these firms increase their compensation by managing the timing of their voluntary disclosures.

Although our primary focus is on firms with fixed award schedules, we replicate all of our tests using the group of firms with unscheduled awards. In marked contrast to our findings for scheduled awards, we find no evidence that the significant stock price decrease (increase) in the period immediately before (after) the unscheduled award reflects an opportunistic disclosure strategy. Thus, taken together, our findings suggest that the asymmetric stock price movements around option awards reflect two distinct sources of opportunistic behavior aimed at increasing CEOs’ stock option compensation: opportunistic timing of management voluntary disclosures around award dates for firms with scheduled awards, and opportunistic timing of awards around news announcements for firms with unscheduled awards.

Our study contributes to the literature on executive compensation by providing evidence consistent with CEOs managing investors’ expectations around scheduled awards to increase their stock option compensation. Much of the prior literature on compensation-related opportunistic behavior focuses on managers’ incentive to manage reported earnings to increase their cash bonuses (Healy, 1985; Watts and Zimmerman, 1986).4 We contribute also to the literature on voluntary disclosure by providing evidence that top executives have compensation-related incentives to accelerate the disclosure of bad news and delay announcements of good news. The personal monetary gain resulting from this disclosure strategy provides a plausible explanation for the intriguing evidence that managers are more likely to voluntarily preempt bad news than good news, and that bad news disclosures often occur shortly before earnings announcements (Skinner, 1994; Kasznik and Lev, 1995).5

The remainder of the paper proceeds as follows. Section 2 provides institutional background relating to CEO stock option awards. Section 3 describes the data and presents descriptive statistics. Section 4 outlines our research design and presents the primary findings. Section 5 provides additional tests, while Section 6 summarizes and concludes the paper.

Section snippets

Institutional background

Stock options are generally awarded to CEOs about once a year at the recommendation of the compensation committee of the board of directors (occasionally there are multiple awards during the year). The role of the committee is to review and approve the compensation package, including any stock option awards, for the company's top executives. The compensation committee exercises discretion over the size and timing of option awards, and these parameters can vary substantially across companies and

Data and descriptive statistics

We collect information about CEO stock option awards between 1992 and 1996 from the Standard & Poor's ExecuComp database and proxy statements filed with the SEC. ExecuComp provides detailed executive compensation data for approximately 1,500 firms (S&P 500, S&P 400 MidCap, and S&P 600 SmallCap). The initial sample includes 5,248 option awards to CEOs of 1,304 firms. ExecuComp reports the expiration date of options awarded during the year, information companies are now required to disclose in

Empirical analyses

Our objective is to investigate whether top executives opportunistically manage the timing of their information disclosures around scheduled option awards. We conjecture that CEOs maximize the value of their awards by delaying good news and rushing forward bad news. We test this prediction using two summary measures for changes in investors’ expectations around scheduled awards, one based on analyst earnings forecasts (Section 4.1), and one based on share prices (4.2 Stock price changes around

Stock price movements around earnings announcements

Because many scheduled awards fall within few days of actual earnings announcements, we examine whether the stock price changes observed in Fig. 1 could be replicated for our sample firms around earnings announcements that are non-concurrent with option awards. For our sample of 572 firms with fixed award schedules, we identify 4,039 quarterly earnings announcements between January 1992 and December 1996 that are at least two months away from a scheduled award. We compute the mean cumulative

Summary and concluding remarks

We investigate whether CEOs manage the timing of their voluntary disclosures around scheduled stock option awards. Because stock options generally are awarded with a fixed exercise price equal to the stock price on the award date, we conjecture that CEOs manage investors’ expectations around award dates by delaying good news and rushing forward bad news. We document changes in share prices and analyst earnings forecasts around scheduled awards that are consistent with our conjecture. We also

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  • Cited by (0)

    We appreciate the helpful comments and suggestions from workshop participants at the 1998 Stanford Accounting Summer Camp, 1999 Duke/UNC Fall Camp, 1999 American Accounting Association annual meeting, University of Arizona, Arizona State University, University of British Columbia, University of California at Los Angeles, Columbia University, Georgia State University, University of Michigan, New York University, Northwestern University, Purdue University, University of Rochester, University of Texas at Austin, Washington University, and University of Washington, Kevin Murphy (the referee), and Jerry Zimmerman (the editor). We also appreciate the research assistance of Hung-Ken Chien. David Aboody acknowledges the support of the Anderson School at UCLA. Ron Kasznik acknowledges the support of the Financial Research Initiative, Graduate School of Business, Stanford University.

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