Managerial Incentive Horizon and Firm Information Quality

Abstract

Theoretical models have linked short managerial incentive horizons with managerial strategies to boost stock prices artificially in the short run. The incentives to boost short-term stock prices may be unintended outcomes of managers’ incentive contracts, or may be deliberate and in the interests of current shareholders. Whether the incentives are deliberate or not, to be successful in artificially boosting short-run stock prices, a manager must fool at least some investors into overvaluing the firm. To fool investors, the manager must reduce the transparency, accuracy, and quality of information about the firm. Thus, if short incentive horizons induce managers to pursue strategies to attempt to fool some investors about true fundamental values, then the quality of the overall external information environment of firms should be worse for firms whose managers face short incentive horizons. This is the primary hypothesis we test in this paper. We examine empirically the relation between managerial incentive horizons and several measures of the quality of firms’ information environments. When a firm’s managerial incentive horizon is short, it is more likely to report income-increasing discretionary accruals and to experience “walk downs” of analysts’ earnings forecasts; analyst forecast dispersion and absolute forecast errors are greater; and share turnover is greater. These results are consistent with recent theoretical models in which short incentive horizons induce managers to adopt strategies that reduce the quality of their firms’ information environments and exacerbate information heterogeneity across investors. We also find evidence suggesting that investors at least partly understand these managerial incentives because they attach less credibility to the information in earnings surprises by short-horizon firms.