This paper investigates whether adoptions of executive stock ownership plans coincide with decreased incentives to meet or just beat analysts’ near-term EPS forecasts. Firms often assert that ownership plans focus executives on long-term performance. I find that the impact of these adoptions on meeting or just beating analysts’ EPS forecasts differs depending on whether the plan binds the CEO to reach ownership targets by a specified date. In particular, I find that firms that adopt plans requiring an increase in CEO ownership exhibit a lower propensity to meet or just beat earnings forecasts following plan adoptions. In contrast, firms that adopt plans that require no increase exhibit no change in the propensity to meet or just beat. The results suggest that firms use binding ownership plans to shift executives’ focus from near-term earnings benchmarks to long-term value creation.
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Firms refer to executive ownership requirements by various names, including stock ownership plans, target ownership plans, management stock ownership guidelines, and executive stock ownership guidelines. Appendix 1 discusses ownership plans in detail and includes examples of plans from Omnicom and Compaq Computer.
A concern is that the adoption of stock ownership plans causes executives to engage in income-decreasing earnings management so that stock may be purchased at lower prices on the open market. Managers do not often buy shares to meet this requirement but instead tend to hold future share grants they otherwise might have sold. In later tests, I confirm that, when CEOs are required to increase their ownership, they exhibit a reduction in selling. Furthermore, I find no evidence of an increase in income-decreasing earnings management in the year prior to, the year of, or the year after the adoption of stock ownership plans (untabulated), which is inconsistent with managers depressing stock prices to buy shares.
Firms may use stock ownership plans to reach a commonly stated cultural goal of long-term value creation, but, in later tests, I find no evidence that firms that adopt ownership plans with a stated goal of long-term value creation reduce their propensity to meet or just beat the consensus analyst forecast. This inconsistency between firms’ stated values and their practices is consistent with the results of Loughran et al. (2009), who find that firms with the greatest stated emphasis on ethics are more likely to be “sin” stocks, more likely to be defendants in class action lawsuits, and more likely to exhibit poor corporate governance scores.
Survey evidence suggests that CEOs exert the greatest influence over corporate culture (Graham et al. 2017). In Section 5, I examine whether the cultural shift I document is consistent with fixed, idiosyncratic CEO styles or with the board and the CEO jointly determining corporate culture (Fee et al. 2013).
I define all variables in Appendix 2.
Krishnan et al. (2011) find that social ties significantly increase firms’ propensities to manage earnings to meet or just beat consensus analyst EPS forecasts, and the authors report in Table 3 that the relation disappears after The Sarbanes–Oxley Act of 2002 (SOX). Thus, insofar as social ties drive the results, the results should not hold in the post-SOX period. I delete all observations before SOX, and my inferences are unchanged (untabulated).
See Hainmueller (2012) for details on the weighting procedure.
An alternative dependent variable is the interaction of meet or just beat and an indicator variable equal to one when the CEO sold shares in the subsequent quarter and zero otherwise. Inferences are qualitatively similar when using this alternative dependent variable (untabulated).
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This paper is based on my dissertation at the University of Iowa. I thank my dissertation committee members Dan Collins (co-chair), Paul Hribar (co-chair), Erik Lie, Dave Mauer, and Rick Mergenthaler. I also received helpful comments from Ciao-Wei Chen, Asher Curtis, Patricia Dechow (the editor), Peter Demerjian, Weili Ge, Tim Gray, Shane Heitzman, Jaewoo Kim, Sarah McVay, Paige Patrick, Katie Spangenberg, Joanna Wu, Ira Yeung (AAA discussant), Jerry Zimmerman, two anonymous reviewers, and workshop participants at Purdue University, Washington University in St. Louis, the Universities of California - Berkeley, Illinois, Iowa, Minnesota, Oregon, Rochester, and Washington, and the 2014 AAA Annual Meeting. Eric Haberkorn, Jiarui Han, Jon Ide, Ruby Boram Lee, Zhixiang Song, and Baoxing Sun provided excellent research assistance. I gratefully acknowledge generous financial support from the University of Washington.
Appendix 1 Background and disclosure examples
Stock ownership plans require executives to hold a minimum amount of firm stock within a specified amount of time and maintain at least that amount afterwards. In a survey of 440 companies, Ayco (2012) reports that approximately 80% of companies use a multiple-of-salary approach, in which the plan requires the named executives to own shares proportional to their salaries. The multiple is typically higher for the CEO than for the other executives. Among firms that employ the multiple-of-salary approach, Ayco (2012) reports that plans require CEOs to retain stock ownership between two and 25 times their annual salary. Ownership requirements of five and six times salary are the most common, representing 42% and 16% of all plan requirements, respectively. The second tier of requirements, typically for executives such as the chief financial officer and the chief operating officer, range from 0.5 to eight times annual salary. For this tier, 56% of plans set minimum ownership between three and four times salary (Ayco 2012). For companies with volatile returns, a drawback of the multiple-of-salary approach is that the number of shares that an executive must own will fluctuate substantially.
The specific-number-of-shares approach addresses this drawback. This approach requires that executives named in the plan own a specified number of shares, and the amount is typically higher for the CEO than for the other executives. The following are two examples of stock ownership plan disclosures that come from my sample.
Example 1: Omnicom Group Inc.
“We have adopted Executive Stock Ownership Guidelines that require the named executive officers to hold shares of Omnicom common stock with a value equal to the specified multiples of base salary indicated below. These guidelines ensure that executives in the positions listed below build and maintain a long-term ownership stake in Omnicom’s stock that will align their financial interests with the interests of the Company’s shareholders. For the named executive officers the guidelines are as follows:
President and Chief Executive Officer of Omnicom: 6 x Annual Base Salary
Chief Financial Officer of Omnicom: 3 x Annual Base Salary
Chief Executive Officer of Diversified Agency Services: 3 x Annual Base Salary
Chief Executive Officer of BBDO Worldwide: 3 x Annual Base Salary
Chief Executive Officer of Omnicom Media Group: 3 x Annual Base Salary
The guidelines were adopted in the first quarter of 2010 and the executives have five years from the date of the adoption of these guidelines or from the date of their appointment as an executive officer, whichever is later, to attain the ownership levels.” Definitive 14A of Omnicom Group Inc. (2010).
Example 2: Compaq Computer Corp.
“In addition, effective September 29, 1995, the Board of Directors adopted an Executive Stock Ownership Policy that requires executive officers to own a certain number of shares of Common Stock. Mr. Pfeiffer is required to own 45,000 shares and each of the other executive officers is required to own 10,000 shares. Each employee subject to this policy has the greater of three years from the effective date of the policy or five years from election to a covered position to comply with the ownership requirement.” Definitive 14A of Compaq Computer Corp. (1996)
Appendix 2 Variable definitions
|AUD INDUS EXPRT||Indicator equal to one when a firm uses an audit industry expert, zero otherwise|
|AUDIT MEMBERS||Number of members of board who serve on audit committee|
|BIGN||Indicator equal to one for firms that use a Big N audit firm, zero otherwise|
|BOARD IND||Proportion of board members who are independent directors|
|CAPEX||Capital expenditures divided by ending total assets|
|CEO CHAIR||Indicator equal to one for firms where the CEO is also the chair of the board of directors|
|CEO EQUITY COMP||For years before 2006, the natural logarithm of the sum of one, the dollar value of restricted stock grants, and the Black-Scholes dollar value of options granted. For years equal to or after 2006, the natural logarithm of the sum of one, the dollar value of stock awards under FAS 123R, and the dollar value of option awards under FAS 123R (in thousands)|
|CEO INCREASE||Indicator equal to one for firms that require the CEO to increase ownership, zero for firms that adopt a plan requiring no increase in CEO ownership|
|CEO RESTRICT STK||Natural logarithm of one plus the CEO’s restricted stock (in thousands)|
|CEO OWNERSHIP||CEO’s stock ownership value scaled by market value of equity|
|CEO TENURE||CEO tenure (in years)|
|CEO TURNOVER||Indicator equal to one for CEO turnovers in the current year, zero otherwise|
|CEO VEGA||Sensitivity of executive wealth to equity volatility, calculated following Core and Guay (2002)|
|DEDICATED||Dedicated ownership percentage following Bushee (1998)|
|DIR OWNERSHIP||Proportion of voting shares held by the board of directors|
|DISC EXP||R&D plus advertising divided by ending total assets, with missing values of R&D or advertising set equal to zero|
|E INDEX||Sum of the number of the following six provisions in place at a firm: poison pills, staggered boards, golden parachutes, limits to shareholder bylaw amendments, supermajority requirements for mergers, and supermajority requirements for charter amendments|
|GOV MISSING||Vector of indicator variables equal to one when a particular governance variable (e.g., BOARD IND or DIR VOTING) is missing, zero otherwise|
|LEV||Total liabilities divided by total assets|
|LOG CEO SALES||Natural log of one plus the market value of stock sold by the CEO (i.e., Thomson Reuters Insiders Data rolecode “CEO”) between the date of the earnings announcement and one day before the following quarter’s earnings announcement|
|MJB||Indicator equal to one when a firm’s EPS is between zero and two cents above the I/B/E/S consensus analyst forecast, zero otherwise|
|MTB||Market value of equity divided by book value of equity|
|POST||Indicator equal to one for firm-years in post-adoption period, zero otherwise|
|PRICE||Stock price as of the fiscal year-end|
|RETURN||Buy-and-hold stock return measured over 12 months|
|ROA||Income before special items divided by average total assets|
|SIZE||Natural logarithm of one plus total assets (in millions)|
|SOX||Indicator equal to one for years after the enactment of the Sarbanes-Oxley Act of 2002, zero otherwise|
|σRETURNS||Standard deviation of daily stock returns measured over one year|
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Quinn, P.J. Shifting corporate culture: executive stock ownership plan adoptions and incentives to meet or just beat analysts’ expectations. Rev Account Stud 23, 654–685 (2018). https://doi.org/10.1007/s11142-018-9442-6
- Corporate culture
- Analyst forecasts
- Managerial ownership
- Benchmark beating
- Corporate governance