SYNOPSIS

In this study, focusing on the period 1996–2010, we conduct an empirical investigation of how warnings by industry peer firms about future earnings affect CEO compensation structure. These warnings contain information about the industry, signaling dim industry prospects and possibly triggering negative spillovers on stock prices. We predict that firms respond to industry-wide negative information by changing the compensation mix to make it more future oriented and by reducing pay-performance sensitivity to shield CEOs from negative factors beyond their control. We find that (1) for firms that issue warnings, peer warnings are associated with a reduction in pay-performance sensitivity; and (2) for firms that do not issue warnings, peer warnings are associated with a modification in compensation mix, such that it becomes more equity based and future oriented, similar to the adjustment made to CEO compensation in the wake of self-warnings. Our results are robust to different definitions of warnings and to the exclusion of annual earnings warnings. However, the results do not hold after 2005, which may be due to factors such as a decline in the use of option compensation, a decrease in the issuance of warnings outside of the announcement window, and changing patterns in management guidance behavior.

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