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Isho Tama-Sweet Oregon State University October 19 , 2011

Do managers alter the tone of their earnings announcements around equity compensation transactions?. Isho Tama-Sweet Oregon State University October 19 , 2011. College of Business Research. Why bother? It is expensive and time consuming Production of new knowledge We are social scientists

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Isho Tama-Sweet Oregon State University October 19 , 2011

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  1. Do managers alter the tone of their earnings announcements around equity compensation transactions? Isho Tama-Sweet Oregon State University October 19, 2011

  2. College of Business Research • Why bother? • It is expensive and time consuming • Production of new knowledge • We are social scientists • Business is more interesting (to us) than biology or nuclear physics • Consequential belief revision • Examples

  3. What is my paper about? • Do managers alter the tone of their earnings announcements around equity compensation transactions? • Who are managers? • What is tone? • What is an earnings announcement? • How does it impact stock price? • What are equity compensation transactions?

  4. Contribution • Investigate a specific strategy by which managers could potentially increase wealth • Opportunism vs. truthfulness in disclosure • Increase our understanding of how managers use narrative disclosure • More and more of it (i.e. annual report length) • How is it being used • Not audited

  5. Prior literature: Credible Disclosure • Tone captures (at least partially) the information content of narrative disclosure • Davis et al. (2008), Henry and Leone (2009), Henry (2008) • Davis and Tama-Sweet (2010) • Credible disclosure can increase the value of managers’ human capital • Managers use flexibility in disclosure to reduce information asymmetry • Stocken (2000)

  6. Prior literature:stock option grants • Option compensation • Options value inputs • Options grants are almost always ‘at the money’ • Maximizing option value at the grant date • Timing the grant (i.e. disclosure date is fixed) • Yermack (1997) • Backdating • Herron and Lie (2007), Narayanan and Seyhun (2007) • Timing of disclosures (i.e. grant date is fixed) • Aboody and Kasznik (2000) • Downward earnings management • Baker et al. (2008), McAnally et al. (2008)

  7. Prior literature:insider equity sales • Option exercises usually become insider sales • Motivations for insider sales • Firm specific: information • Manager specific: taxes, liquidity, diversification • Maximizing option value upon exercise • Exercise options after earnings management • Bartov and Mohanram (2004) • Bergstresser and Philipon (2006) • Sell more equity after just meet or beat • Cheng and Warfield (2005)

  8. Hypotheses H1a and H1b • H1a: The optimistic tone in the earnings press release is lower when the CEO receives an option grant in the quarter following the press release. • H1b: The optimistic tone in the earnings press release is greater when the CEO sells equity in the quarter following the press release.

  9. Timeline QEndtPress releasetQEnd(t+1) Option grant or exercise

  10. Research design: • OPTIMISM_PRit = a + b1GRANTit + b2SALEit + CONROLS + e (1) • H1a predicts b1 is negative • H1b predicts b2 is positive • Data: 1998-2007, about 19,000 observations • Financial data and press release

  11. Control variables • Controls based on NIRI guidelines • Current firm performance (ROA, LOSS, BEAT, SURP, LOGREV) • Prior period performance (SD_ROA, PCT_JMOB) • Length of press release (LOGWC) • QTR, YEAR and INDUSTRY indicators • Financial metrics: ACCR, SI_DUM, DA, MB

  12. Results of returns tests • Linking unexpected optimistic tone to changes in CEO wealth • Estimate magnitude of relation between CAR_PR and UNEXP_OPT • Compute change in value of CEOs’ wealth for a 1 StdDev change in UNEXP_OPT • Low wealth change compared to overall compensation

  13. Sensitivity and robustness Scheduled option grants Pre/post SOX (backdating of options) Quarters in which CEO received grant and sold equity Sales of equity from option exercise only Litigation risk Alternative measure of HL_OPT Test by quarter Alternate model of expected OPTIMISM in returns tests

  14. Conclusion • I provide limited evidence to support the predictions that managers alter the tone of their earnings announcements around stock option transactions • Contribution • Choices in narrative disclosure • Trade-off of credibility and opportunism • Litigation as constraint

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