Can Contracting on Career Concerns Induce CEOs to Provide Timely Disclosure of Bad News?

Abstract

Theory argues that career concerns (i.e., concerns about the impact of current performance on contemporaneous and future compensation) encourage managers to withhold bad news disclosures. However, empirical evidence regarding the extent to which a manager’s career concerns are associated with a delay in bad news disclosure is limited. We first confirm the finding of bad news delay in Kothari, Shu, and Wysocki (2009) using their method of inferring bad news delay from investors’ stronger reaction to bad news relative to good news management forecasts. We then investigate whether the extent of bad news delay is associated with career concerns. Across multiple proxies for career concerns, we find that the extent to which managers delay the disclosure of bad news is positively associated with their level of career concerns. Finally, we hand-collect data on an explicit compensation contract that firms use to reduce their CEO’s career concerns (i.e., ex-ante severance pay agreements). We find that if the firm promises managers ex ante a sufficiently large payment in the event of dismissal, they no longer delay the disclosure of bad news relative to good news. Overall, our findings support prior theoretical evidence that managers delay bad news disclosure due to career concerns and suggest a mechanism through which firms can mitigate the delay.