Abstract
We examine the relation between the option compensation received by corporate managers and the extent of optimistic bias in their earnings forecasts. Specifically, we are interested in the extent to managers with a high amount of option compensation tend to have a self-serving optimism. We examine whether there is evidence consistent with the argument that managers have a self-serving interest to issue optimistic forecasts since their compensation is a function of stock price and higher earnings usually result in a higher share price. We hypothesize that management’ optimism (optimistic bias in their earnings forecasts) increases as their stock option compensation increases. Our empirical evidence indicates that highly compensated managers are associated with the likelihood of issuing upwardly biased (i.e. more optimistic) earnings forecasts.
Highlights
Will management, with significant option compensation, behave differently when issuing their earnings forecasts? Research suggests that the variation in managements' behavior is linked to the timing of their stock-option compensation (Yermack, 1997; Aboody & Kasznik, 2000; Cheng and Lo, 2006; McAnally, Srivastava & Weaver, 2008) and managing earnings through discretionary accruals (Bergstresser & Philippon, 2006; Gong, Li & Xie, 2009)
It seems appropriate to ask whether optimistic forecast biases are reflected in higher portions of compensation arrangements: Will management with significant option compensation behave differently when issuing an earnings forecasts? We address the question by studying the effect of CEO compensation on CEO optimism, since CEOs are most likely to have the strongest influence on earnings forecasts
These results provide preliminary evidence that managers with high stock option compensation issue more optimistic forecasts
Summary
With significant option compensation, behave differently when issuing their earnings forecasts? Research suggests that the variation in managements' behavior is linked to the timing of their stock-option compensation (Yermack, 1997; Aboody & Kasznik, 2000; Cheng and Lo, 2006; McAnally, Srivastava & Weaver, 2008) and managing earnings through discretionary accruals (Bergstresser & Philippon, 2006; Gong, Li & Xie, 2009). With significant option compensation, behave differently when issuing their earnings forecasts? Bergstresser and Philippon (2006) and Gong et al, (2009) report that managers with significant stock and option holdings have more flexibility, and use discretionary accruals to manage earnings. Given these findings, it seems appropriate to ask whether optimistic forecast biases are reflected in higher portions of compensation arrangements: Will management with significant option compensation behave differently when issuing an earnings forecasts? Chi & Ziebart (2019) suggest attributes of management earnings forecasts may indicate managements’ intentions to manage earnings that may result in a restatement
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