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CEO career concerns and the precision of management earnings forecasts

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Abstract

We extend the research on how CEOs address career concerns during their early tenure in firms and we argue that CEOs use a forecast precision strategy to highlight or obfuscate information in a way that may help them convey favorable signals on their abilities. Our findings show that new CEOs are more likely to increase forecast precision when the underlying forecast news is better to highlight positive signals and they will obfuscate more negative news by lowering forecast precision to moderate investors’ negative reaction. Additionally, our results show that CEOs especially use this approach when firms are headquartered in the states that have stricter enforceability of non-compete clauses. We also find that the association between forecast precision and forecast news is stronger when institutional monitoring is weak, CEOs are young, and/or hired from outside the firm. Our main findings remain unchanged when only quarterly forecasts are used in the analyses and are robust to different early tenure cutoffs.

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Availability of data and material

All data used in this study are publicly available from sources identified in the paper.

Notes

  1. Jenter and Kanaan (2015) examine the association between firm performance and CEO turnover and report that firms associated with forced CEO dismissal show negative returns to the extent of -19.39% over the 12 months. These findings thus provide support to the expectation that CEOs’ lower performance effectiveness may result in their dismissal.

  2. We also conduct sensitivity tests by using the cutoff points of two and four years instead. There is no significant change in empirical inferences.

  3. As explained in Sect. 3 (Eq. 3), the variable of Strategy is coded as 1 if precision of all positive MEFs issued by new CEOs is higher than the expected precision and the precision of negative news is lower than the expected precision during the test period, otherwise 0.

  4. The CEO-firm match means that CEOs do not move from one firm to another firm during the period. If he/she switches to another firm, we will count the new CEO-firm match as a different observation.

  5. The variable Strategy is defined in the methodology section after Eq. 3.

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Funding

Kexing Ding is supported by the Fundamental Research Funds for the Central Universities.

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Authors and Affiliations

  1. Southwestern University of Finance and Economics, Chengdu, 611130, China

    Kexing Ding

  2. Professor Emeritus of Accounting, Department of Accounting and Information System, Rutgers Business School, Newark-New Brunswick, 100 Rockafeller Ave, Piscataway, NJ, 08540, USA

    Bikki Jaggi

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Appendix

Appendix

Variable measurement

Main dependent variables

 

Precision

Precision

Management forecast precision is defined as the difference between the high- and low-end estimates, divided by the absolute value of the mid-point of the estimate, taking negative value; for point estimate, precision is 0

Turnover

Turnover is an indicator variable equal to 1 if the manager leaves the office within the first three years of their tenure in the CEO position, and 0 otherwise

Hit

Hit is an indicator variable that is equal to 1 if the actual earnings fall into the forecast range, and 0 otherwise. For point forecasts, Hit equals to 1 if the actual earnings equal the forecast

Main independent variables

News

Forecast news is defined as the difference between mid-point of management forecasts (value of forecast if it is a point estimate) and the analyst consensus of the analyst forecasts issued within 90 days prior to the management forecasts

Early

Indicator variable equals to 1 if the management forecast is issued by CEOs within the first three years of a CEO’s service

Strategy

Strategy is coded as 1 if precision of the positive news forecasts issued by the new CEO is higher than the expected precision and precision of negative news forecasts is lower than the expected precision during the test period, and 0 otherwise

Other variables

Size

Firm’s market capitalization; we use the log transformation in the correlation matrix and regression analysis

MTB

Market-to-book ratio, calculated as the ratio of the market capitalization of equity divided by the book value of equity at the end of the quarter before the forecast;

Age

CEO’s age

FirmAge

Firm’s age measured as the number of years the firm appear in CRSP database

Loss

Loss indicator, defined as 1 if the actual EPS is negative for this quarter and zero otherwise

Return Volatility

Return volatility is defined as the standard deviation of daily stock returns over the 250 trading days prior to the management forecast release date

Analyst Dispersion

Analyst dispersion is calculated as the standard deviation of the analyst forecasts issued in the 90 days before management forecasts

Analyst Coverage

Analyst coverage is defined as the number of unique analysts who provide earnings forecasts in the 90 days before management forecast, taking logarithm

Horizon

The number of days between the forecast date and the fiscal period end date, taking logarithm

R&D

Research and development expenditures divided by total assets, set to zero if missing

InstOwn

Institutional ownership is defined as the percentage of shares held by institutional investors

Ability

Managerial ability measure developed by Demerjian et al. (2012)

Annual

Annual indicator variable set to 1 if the management forecast corresponds to annual earnings and 0 if quarterly

Accuracy

Accuracy of the forecast measured as the absolute difference between the management forecast and the true earnings, scaled by the true earnings, taking negative value

EM

EM is the earnings management variable, as captured by modified Jones model (Dechow et al. 1995)

Strategy

Strategy is coded as 1 if precision of the positive news forecasts issued by the new CEO is higher than the expected precision and precision of negative news forecasts is lower than the expected precision during the test period, and 0 otherwise

Seasoned-CEO

Season-CEO is coded as 1 if the CEO is in the current position for more than three years

EarlyDismissal

EarlyDismissal is set to 1 if the CEO is fired within three years after he/she takes the position

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Ding, K., Jaggi, B. CEO career concerns and the precision of management earnings forecasts. Rev Quant Finan Acc 58, 69–100 (2022). https://doi.org/10.1007/s11156-021-00988-z

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