Management Earnings Forecasts as a Performance Target in Executive Compensation Contracts

Shota Otomasa, Atsushi Shiiba and Akinobu Shuto
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Shota Otomasa: Kansai University
Atsushi Shiiba: Osaka University
Akinobu Shuto: The University of Tokyo

No CARF-F-368, CARF F-Series from Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo

Abstract: This paper investigates whether and how Japanese firms use management earnings forecasts as a performance target for determining executive cash compensation. Consistent with the implications of the principal-agent theory, we find that the sensitivity of executive cash compensation varies with the extent to which realized earnings exceed initial management forecasts. In particular, we find that, for a sample of Japanese firms comprising 14,899 firm-year observations from 2005 to 2012, the executive cash compensation is positively related to management forecast error (MFE). Moreover, we show that the relationship between executive cash compensation and MFE strengthens when realizing positive MFEs despite aggressive initial forecasts. Overall, we find that initial management forecasts can be used as a performance target in executive compensation contracts. These findings also suggest that management earnings forecasts are important for improving contract efficiency as well as for providing useful information to investors in the capital market.

Pages: 70 pages
Date: 2015-07
New Economics Papers: this item is included in nep-bec, nep-cse, nep-cta, nep-for and nep-hrm
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Persistent link: https://EconPapers.repec.org/RePEc:cfi:fseres:cf368

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