Understanding top managers’ behavioral quirks is sometimes key to predicting their corporate policy choices. Often overlooked is the speed with which managers and their companies report good news versus bad news.[1] Which do they tend to report faster? The answer has significant implications for both investors and debt holders, making it equally important for those who set accounting standards.

Good news may include unrealized gains; bad news could include asset impairments or bad debts. Capital providers – investors and debt holders – clearly want to know bad news as soon as possible. Early awareness helps them make faster, better-informed financial decisions, such as whether to hold or sell stocks or reevaluate the yield on their debts. This preference is well-documented in the literature[2]. A 2014 experimental study separated the “news-givers” from “news-receivers” and observed that, given a choice between good and bad news, about 75 percent of the “news receivers” prefer to hear bad news first. However, in the business which type of news do top managers – the ones delivering the news to the capital providers – prefer to report first.

How Quickly “High-Ability” Managers Report Bad News

In a recent study, we examined this question by focusing on the “high-ability” and the most capable managers, as identified by their ability to generate higher profits. Research has shown that these managers deliver better financial results[3], more accurate forecasts[4], higher earnings quality[5], and smarter tax planning[6]. Additionally, they tend topromote a strong culture of accountability within their firms and are less likely to be dismissed for poor performance. Since high-ability managers deliver corporate results that benefit the firm’s capital providers, they earn substantial discretion over policies that would normally be unavailable to managers of a financially constrained firm. Thus, examining high-ability managers’ financial-reporting policies would provide a better and clearer understanding of their true financial reporting preferences.

We posited that high-ability managers are likely to delay reporting bad news for three main reasons. The first reason has to do with control. Even in the best cases, being transparent about negative outcomes reduces managers’ ability to control the narrative about their firms in front of capital providers and increases their accountability. Therefore, as a preemptive measure, even high-ability managers would want to delay reporting bad news. Second, faster disclosure of bad news risks rendering reported earnings uninformative and increasing the risk of lower executive compensation. Finally, we expected that even the innate behavior of managers would discourage the earlier disclosure of bad news. Several social-psychology studies have documented that, when both good and bad news are available, people intuitively prefer to report the good news first[7].

As expected, our findings show that even the most competent managers often delay sharing bad news. This prompts another important question: Why should capital providers tolerate these management tendencies in financial reporting?

When Corporate Risks Increase

To answer this question, we looked at how high-performing managers respond under pressure and found that they still tend to delay sharing negative news. Despite a company facing several types of risks, including heavy debt loads, rising default risk, or fraud litigation, high-ability managers often hesitate to disclose negative developments promptly. This pattern indicates that, despite higher corporate risks, capital providers struggle to push these managers to be more transparent. In other words, even in crisis, high-ability leaders often control the timing of bad news, and external stakeholders have limited power to expedite the process.

Conclusion

This study offers lessons for managers, capital providers, and standards-setters. Managers should recognize that personal preferences and behavioral idiosyncrasies can shape a company’s financial reporting policies, which may not always align with the interests of capital providers. Being aware of this phenomenon can help reduce delays in reporting bad news in financial reporting.

For capital providers and standards-setters, this study highlights more than just a management quirk. It shows that, although it is widely accepted that capital providers prefer faster disclosure of bad news, some talented and capable managers still hesitate to comply. Why would capital providers accept this? One reason may be that high-ability managers are hard to replace, so capital providers overlook this behavior. Additionally, we observe no decline in other measures of earnings quality, which may make capital providers more willing to tolerate slower reporting of bad news, especially when they trust an organization’s culture. Drawing on a new machine-learning tool to inspect corporate communications, we confirmed that when a company’s culture shows strong integrity, capital providers are more accepting of these delays.

 Still, our research points to a notable behavioral trait that affects how quickly and when bad news is reported among the most valuable and high-performing managers. If ignored, a significant delay in reporting bad news could harm some firms and their capital providers.

ENDNOTES

[1] See Mora & Walker (2015)

[2] See Ruch & Taylor (2015).

[3] See Demerjian, Lev, & McVay (2012).

[4] See Baik, Farber, & Lee (2011).

[5] See Demerjian, Lev, Lewis, & McVay (2013).

[6] See Koester, Terry, & Wanger (2016).

[7] See Legg & Sweeny (2014).

REFERENCES

Baik, B., Farber, D. B., & Lee, S. (2011). CEO ability and management earnings forecasts. Contemporary Accounting Research, 28(5), 1645-1668.

Demerjian, P. R., Lev, B., & McVay, S. (2012). Quantifying managerial ability: A new measure and validity tests. Management Science, 58(7), 1229-1248.

Demerjian, P. R., Lev, B., Lewis, M. F., & McVay, S. E. (2013). Managerial ability and earnings quality. The Accounting Review, 88(2), 463-498.

Koester, A., Terry, S., & Wanger, D. (2016). The role of managerial ability in corporate tax avoidance. Management Science, 63(10), 3285-3310.

Legg, A. M., & Sweeny, K. (2014). Do you want the good news or the bad news first? The nature and consequences of news order preferences. Personality and Social Psychology Bulletin, 40(3), 279-288.

Mora, A., & Walker, M. (2015). The implications of research on accounting conservatism for accounting standard setting. Accounting and Business Research, 45(5), 620-650.

Ruch, G. W., & Taylor, G. (2015). Accounting conservatism: A review of the literature. Journal of Accounting Literature, 34, 17-38.

Shibashish Mukherjee is an assistant professor of corporate finance at Emlyon Business School, France; Shuo Wang is an assistant professor of financial accounting at the University of Edinburgh Business School, the UK; and Mustafa Reha Okur is an assistant professor at Izmir University of Economics, Turkey. This post is based on their recent paper, “Trust, but Verify: Managerial Ability and Conditional Accounting Conservatism,” available here.