Pessimistic Earnings Guidance Before Annual Incentive Plan Approval

Corporate boards determine the performance metrics for CEOs’ annual incentive plans (AIPs) in compensation committee meetings at the beginning of each fiscal year. We provide evidence that management tends to issue pessimistic earnings guidance ahead of these meetings (“event-window guidance”), and that this pessimistic guidance leads analysts to lower their earnings forecasts, which commonly serve as an anchor for setting AIP performance goals. This pessimism in event-window earnings guidance is present when performance goals are linked to measures such as Earnings-Per-Share (EPS), but not when they are linked to revenue, providing further evidence that pessimistic event-window guidance is motivated by a desire to manipulate executive compensation. In the cross section, pessimistic event-window guidance is more pronounced when analyst forecasts are optimistic, when the EPS performance target was missed in the previous year, when the target payout amount is large, or when shareholders actively monitor the firm. Lastly, pessimism in event-window guidance is associated with higher bonus payouts. Overall, our study sheds light on the strategic role of management disclosure policy in the executive compensation process.