Executive Compensation and Analyst Guidance : The Link between CEO Pay and Expectations Management

During the last decade, a surprisingly high percentage of U.S. companies has fulfilled or beatenanalysts´ earnings per share forecasts. One of the most frequently cited reasons for this growingtendency is a change in the nature of U.S. executive compensation structure. As stock options havebecome an increasingly important part of executive compensation, the preservation or enhancementof short term stock value around the earnings announcement has become a priority for managers.Besides earnings management, a widespread way to meet analyst expectations is to inject pessimisminto their forecasts by providing analysts with negative clues, or so-called downward guidance. Thispaper is the first to investigate the relationship between the practice of analyst guidance and executivecompensation packages. We document a strong link between expectations management and therelevant options component of CEO compensation, bonus plan payments, and the value of the firm'sshares owned by its managing CEO. In a second set of tests, we show that firms that meet or beatanalyst forecasts at the earnings announcement generate positive abnormal returns, which aresignificantly lower for firms suspected of managing expectations.