Intended Benefits and Unintended Consequences of Improved Performance Disclosure, Job Market Paper
ABSTRACT: In response to the call for additional evidence of the economic effects of disclosure (Leuz and Wysocki, 2016), I document significant unintended consequences of a seemingly innocuous, well-intentioned disclosure rule change. In 1998, the SEC required that all funds disclose a self-selected, primary benchmark. Benchmark reporting varied among actively managed mutual funds: some compared performance to a single benchmark, but most mentioned multiple benchmarks or none at all. The new disclosures should be relatively uninformative for sophisticated investors because they recognize that benchmark choice is strategic, and they observe independent “best fit” benchmarks from Morningstar. However, I find that fund flows for institutional investors become more sensitive to performance relative to the disclosed benchmark, whereas retail investors—presumably the SEC’s focus—remain unaffected. Turning to fund manager responses to the disclosure change, I document significant real effects (where disclosure changes fund behavior) and externalities (where strategic benchmark disclosure alters market share). I find that two-thirds of funds select an inaccurate benchmark and outperform non-strategic funds via higher risk taking. The new disclosures also exacerbate the well-documented tendency of underperforming fund managers to increase risk in the second half of the year.
CFO Co-Option, Earnings Targets, and CEO Compensation, with Shane S. Dikolli, William J. Mayew, and Mani Sethuraman
ABSTRACT: We study whether power dynamics in the CEO-CFO relationship influence the CEO’s compensation. To operationalize CEO-CFO power dynamics, we define CFO co-option as the appointment of a CFO after a CEO assumes office. We find that CFO co-option is associated with a CEO pay premium of about 5.5%, which is partially explained by a higher likelihood that the firm achieves analyst based earnings targets. Our evidence also indicates that the primary mechanism through which co-opted CFOs achieve earnings targets is by walking down analyst forecasts over a fiscal year rather than using discretionary accruals to inflate earnings. The evidence thus suggests that co-opted CFOs are more likely to manage expectations about earnings rather than manage earnings directly to achieve earnings targets.
Managerial Response to Non-Fundamental Price Shocks, with Yukun Liu and Ben Matthies
ABSTRACT: We find that managers significantly alter their behavior in response to non-fundamental declines in price. In particular, after an exogenous, non-fundamental price drop, managers increase their disclosure quality, and shift accrual earnings management to real earnings management. Moreover, managers with high equity incentives engage more in real earnings management, while managers at firms with high litigation risk tend to increase their disclosure quality and decrease accrual earnings management. We confirm that the net effect of earnings management, in response to non-fundamental price shocks, results in firms more frequently reporting “suspicious” earnings. Firms that experience large non-fundamental price declines are more likely, on average, to meet or beat analysts’ earnings expectations by 1 or 2 cents in our sample. Our findings suggest that non-fundamental price variation is an important driver of firm disclosure policy and earnings management.
CEO Pay and the Lake Wobegon Effect after Improved Compensation Disclosure
ABSTRACT: Recent CEO compensation growth has been criticized as excessive and disconnected from managerial ability. The “Lake Wobegon Effect” (LWE) suggests that boards, unwilling to signal a weak CEO, match CEO compensation growth with competitors even when their firm underperforms. Following the Compensation Discussion and Analysis (CD&A) rule change occurring in 2006, I find evidence rejecting the hypothesis that excess compensation is driving recent CEO compensation growth. Total inflation-adjusted median CEO compensation grew by 7.1% per year since the CD&A rule change. However, absolute excess compensation significantly declined post-CD&A, with total CEO pay growth becoming more related to firm fundamentals. Additionally, excess CEO compensation becomes positively associated with proxies for managerial ability post-2005. This rejects a core requirement for the LWE to affect compensation growth—that firms are overpaying CEOs for “illusory superiority.” The evidence suggests that the growth in CEO compensation from the late 2000s through the early 2010s is not due to the LWE.
WORKS IN PROGRESS
Cross-Sectional Variation in the Bid-Ask Spread Around Earnings Announcements, with Neil Bhattacharya, Bidisha Chakrabarty, and Alina Lerman
Chief Accounting Officers and Firm Efficiency, with Erik Olson and Thomas Steffen