Managers’ Career Concerns and Asymmetric Disclosure of Bad versus Good News

Managers are concerned about how their current performance would influence their current employer’s and the labor market’s assessment of their ability. An unfavorable assessment of their ability can have significant adverse effects, including termination and poor job prospects thereafter. Thus, career concerns are likely to motivate managers to work hard and generate good performance. We further argue that career concerns may also motivate CEOs to withhold bad corporate news and gamble that subsequent corporate events will turn in their favor, enabling them to bury the bad news.  To test our prediction, we consider two situations when CEOs’ career concerns are likely to be higher: the early years of their service and their firms are in U.S. states with higher enforceability of noncompetition employment contracts. We show that CEOs are more likely to withhold bad news relative to good news in these situations.

There is likely to be more uncertainty about CEOs’ ability in the early years of their service and information about corporate performance during that time would have a greater influence on the assessment of CEOs’ ability. Thus, CEOs would have a greater incentive to withhold bad news relative to good news in the early years of their service to favorably influence the market’s assessment of their ability. For CEOs who stay beyond the early years in office, there is less uncertainty about their ability, since they have survived several retention/dismissal decisions by the board of directors. Thus, in the later years in office, these CEOs’ incentive to favorably influence the assessment of their abilities by withholding bad news relative to good news decreases. They would also be more concerned about protecting the reputation they would have established, further reducing their incentive to behave opportunistically in terms of withholding bad news. Based on the above arguments, we predict that CEOs are more likely to withhold bad news relative to good news in the early years of their service than in the later years.

CEOs’ career concerns are also greater when the degree of enforceability of noncompetition agreements is greater in the U.S. states in which their firms are headquartered. Commonly used in CEO employment contracts, noncompetition agreements may impose certain restrictions on managers from joining or forming a rival company for a pre-specified period of time upon their dismissal. Stricter enforcement of these agreements is likely to make managers more concerned about losing their job. Thus, we predict that managers of firms in states with higher enforceability of these agreements are more likely to delay the disclosure of bad news relative to good news.

We follow Kothari, Shu, and Wysocki (2009)[1] and estimate managers’ tendency to withhold bad news relative to good news by examining stock price behavior around two types of discretionary corporate disclosures: management earnings forecasts and announcements of dividend changes. These two types of disclosures have been widely used in the voluntary disclosure studies, given the data availability and the ease of classifying them as containing good or bad news. If managers wait and allow bad news to accumulate up to a certain threshold and are able to hide the bad news from the market before formally disclosing it, whereas if they informally disclose or leak good news prior to the public disclosure of the news; then stock market reaction to the public releases of bad news is greater than that of good news as well as a greater fraction of news is impounded in stock prices prior to the formal disclosure of good news than of bad news. For the sample period 1995-2010, we find that the difference in five-day cumulative abnormal stock returns for bad news versus good news management earnings forecasts is greater in the early (first three) years than in the later (after first three) years of CEOs’ service. Also, the difference in the pre-released news amounts, as reflected in stock prices, between good news and bad news forecasts is larger in the early than in the later years of CEOs’ service (i.e., CEOs earlier in their tenure tend to informally disclose good news and wait for formal announcements to disclose accumulated bad news). These associations are weaker for firms with higher institutional ownership, larger analyst following, and greater board of directors’ independence. These results support our predictions that CEOs have a greater incentive to withhold bad news in the early years of their service and that their opportunistic disclosure behavior is less pronounced in firms with stronger monitoring of disclosure policy. Our conclusions are robust to using a sample of management earnings forecasts that are not bundled with earnings announcements as well as using a sample of dividend change announcements for the period 1992-2013.

Our finding of greater asymmetric withholding of bad news in the early years of CEOs’ service could be driven by low ability CEOs. These CEOs withhold bad news to a greater extent in their early years of service, and they get fired soon thereafter because they are not able to hide bad news for too long due to their continued poor performance. To examine whether high ability CEOs also disclose opportunistically due to career concerns, we repeat our analysis using a subsample of CEOs who stay in office for a relatively long period (at least six years, the median of the number of years a CEO stays in office). These CEOs are likely to be of high ability because they would have survived several termination/retention decisions by the board of directors. Our results continue to hold for this subsample, suggesting that even high ability CEOs have greater incentive to withhold bad news relative to good news in the early than in the later years of their service. During the early years of service, there is likely to be more uncertainty about the ability of these CEOs as well.

Finally, using the enforceability index of U.S. states for the period 1992 to 2004, provided by Garmaise (2011)[2], we find that firms in U.S. states with higher enforceability of noncompetition agreements withhold bad news to a greater extent, consistent with our prediction. Moreover, as expected, this effect is weaker for firms with stronger monitoring of disclosure policies, proxied by greater institutional ownership, analyst following and board independence. These findings further suggest that managers with heightened career concerns have stronger incentives to withhold bad news relative to good news.

Our study makes the following main contributions. To date, understanding in the literature on how managers’ career concerns affect their corporate disclosure strategies in quite limited. Our study suggests that CEOs’ career concerns provide them incentives to delay the disclosure of bad news. Our study also complements Ali and Zhang (2015)[3], who show that firms are more likely to inflate reported earnings in the early years of CEOs’ service. Together, these two studies suggest that in the early years in office, CEOs are likely to favorably influence the assessment of their ability by not only delaying the voluntary disclosure of corporate bad news relative to good news, but also by understating poor performance in their firms’ financial reports. CEOs are unlikely to succeed in favorably influencing the assessment of their ability by delaying the voluntary disclosure of bad news, if they do not overstate corporate performance in their firms’ financial reports as well. It is because the future corporate events which they hope will enable them to bury the withheld bad news may not happen before the next period’s financial reports are released that they end up inflating earnings in those reports.

ENDNOTES

[1] Kothari, S.P., Shu, S., Wysocki, P., 2009. Do managers withhold bad news? Journal of Accounting Research 47, 241–276.

[2] Garmaise, M.J., 2011. Ties that truly bind: Noncompetition agreements, executive compensation, and firm investment. The Journal of Law, Economics, and Organization 27, 376-425.

[3] Ali, A., Zhang W., 2015. CEO Tenure and Earnings Management. Journal of Accounting and Economics 59, 60-79.

The preceding post comes to us from Ashiq Ali, the Charles and Nancy Davidson Chair in Accounting at the Naveen Jindal School of Management, University of Texas at Dallas, Ningzhong Li, Assistant Professor of Accounting at the Naveen Jindal School of Management, University of Texas at Dallas and Weining Zhang, Assistant Professor of Accounting at Cheung Kong Graduate School of Business. The post is based on their recent paper, which is entitled “Managers’ Career Concerns and Asymmetric Disclosure of Bad Versus Good News” and available here.