CEOs, CFOs Pay the Price for Quarterly Earnings Misses

Missing quarterly earning benchmarks can be a professional and personal nightmare for CEOs and CFOs.  That’s according to a new study from three university professors that found earnings misses had a significant impact on compensation and increased chances for termination.

In “CEO and CFO Career Consequences to Missing Quarterly Earnings Benchmarks,” Rick Mergenthaler, University of Iowa, Shiva Rajgopal, University of Washington Business School, and Suraj Srinivasan, University of Chicago, used data on Standard & Poor’s 1500 companies from 1993 to 2004 to evaluate failure to meet quarterly earnings benchmarks against a comprehensive set of career consequences for both CEOs and CFOs.

After controlling for operating and stock return performance, as well as the magnitude of the earnings surprise revealed at the earnings announcement, the authors determined that “the failure to meet quarterly earnings benchmarks, especially the analyst consensus estimates, is associated with lower bonus and equity grants, and a higher probability of forced dismissal for both the CEO and the CFO.”

They further concluded that Boards of Directors “appear to react directly to managers’ ability to meet earnings targets or to the information that is reflected in meeting such benchmarks, and senior managers’ preoccupation with meeting earnings benchmarks might be based at least partly on career concerns.”

The study found that failing to meet two quarterly analyst consensus forecasts in a year is associated with:
• A lower bonus equivalent to 14 percent of the CEO’s and 8 percent of the CFO’s salary
• A lower equity grant of 24 percent relative to an equity grant with no misses for both the CEO and the CFO
• A 0.61 percent higher probability of being dismissed for the CEO and a 0.62 percent higher probability for the CFO.

Failure to meet all four consensus quarterly earnings forecasts in a year resulted in:
• A lower bonus equivalent to 28 percent of the CEO’s and 16 percent of the CFO’s salary
• A lower equity grant of 48 percent relative to an equity grant with no misses for both the CEO and the CFO
• A 1.51 percent (CEO) and 1.53 percent (CFO) higher probability of being dismissed

The authors also found that firms that provide earnings guidance and miss the analysts’ consensus estimates are associated with greater career penalties, and bonus cuts for the CEO are higher if the firm has a history of meeting expectations.  Further, penalties for missing targets have increased in the wake of SOX.

“A couple of misses can potentially damage senior executives’ careers,” the authors concluded.  “…The evidence presented here suggests that boards… factor in the analyst consensus estimates in their evaluation process and punish senior managers for the failure to meet short-run analyst targets.”
 

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