C. Edward Fee is Professor of Finance at Tulane University Freeman School of Business; Zhi Li is Assistant Professor of Finance at Champan University George L. Argyros School of Business and Economics; and Qiyuan Peng is Assistant Professor of Finance at the University of Dayton. This post is based on their recent paper, forthcoming in Journal of Accounting and Economics.
Related research from the Program on Corporate Governance includes Stealth Compensation Via Retirement Benefits by Lucian A. Bebchuk and Jesse M. Fried.
Performance-based stock grant is an increasingly popular form of incentive pay for public firm CEOs in U.S. Under these grants, executives are expected to receive different levels of stock payments (“threshold,” “target,” or “maximum”), contingent on the firm’s meeting pre-specified hurdles by the end of the performance evaluation period. In 2006, the SEC announced new disclosure rules that require firms to report “unearned shares” from outstanding performance-based stock grants in their proxy statement. Unearned shares are the number of shares that executives are expected to receive conditional on whether the firm meets predetermined performance hurdles by the end of the evaluation period.
In our paper, Hidden Gems: Do Market Participants Respond to Performance Expectations Revealed in Compensation Disclosures?, forthcoming in the Journal of Accounting and Economics, we examine whether the disclosed “unearned shares” provide new information about a firm’s future performance. We believe the new disclosure contains forward-looking information for two reasons. First, firms often cite performance expectations over the evaluation period to justify the reported unearned shares. Second, past literature has shown that firms choose specific performance measures that reflect their strategic priorities. These performance criteria, which are often not fully disclosed to the public, may capture information related to CEO actions and firm performance over the long run. However, the disclosure might not be informative. For example, the compensation committee and other corporate insiders might not be able to correctly forecast future firm performance and plan payouts. Or the firm could be unwilling to truthfully reveal inside information. Or the performance-based grants might be poorly designed to be informative, such as the performance hurdles are set at unreasonably high (low) level or the performance measures used are unrelated to firm value. Hence, whether the disclosure of unearned shares is informative is an empirical question.