Stock option compensation and the likelihood of meeting analysts' quarterly earnings targets |
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Authors: | Mark P Bauman Kenneth W Shaw |
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Institution: | (1) School of Business Administration, University of Northern Iowa, Iowa;(2) College of Business, University of Missouri, Missouri |
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Abstract: | One role of stock options in executive compensation packages is to counterbalance the inherently short-term orientation of
base salary and annual bonuses. Managerial compensation plans frequently include stock options in order to better align the
interests of managers and outside shareholders and reduce agency problems. However, since option values are sensitive to fluctuations
in stock prices, and investors reward firms that meet or exceed earnings expectations, executives of firms with sizable option
components in their compensation plans have increased incentives to report earnings that meet or exceed analysts' forecasts.
We show that the propensity to meet or exceed analysts' quarterly earnings forecasts is positively related to the use of options
in top executives' compensation plans. Further, firms that employ relatively more options in their compensation plans more
frequently report earnings surprises that exceed analysts' forecast by small amounts (between 0 and 1 cent per share). These
results suggest that the use of stock-based compensation intensifies top executives' focus on financial analysts' short-term
earnings forecasts. |
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