Uncertainty in Managerss Reporting Objectives and Investorss Response to Earnings Reports: Evidence from the 2006 Executive Compensation Disclosures

Abstract

We examine whether the information content of the earnings report, as captured by the earnings response coefficient (ERC), increases when investors’ uncertainty about the manager’s reporting objective decreases, using the 2006 compensation disclosures as an instrument to capture a decrease in investors’ uncertainty about managers’ incentives and reporting objectives. Using a difference-in-differences design and exploiting the staggered adoption of the new rules, we find a statistically and economically significant increase in ERC for treated firms relative to control firms. The effect is weaker in firms that received a comment letter from the SEC urging them to improve their compliance with the new rules (a proxy for firms less responsive to the new rules), and stronger in firms with more independent boards (a proxy for firms more responsive to the new rules). Our findings represent the first empirical evidence of a role of compensation disclosures in enhancing the information content of financial reports, consistent with the theoretical prediction in Fischer and Verrecchia (2000). As such, they may be of interest to both policy-makers and investors.