Abstract

Purpose: This article investigates how outside directors’ equity compensation affects the quality of analyst earnings forecasts.

Design/methodology/approach: The authors implement firm clustered OLS regression with year, quarter, and industry dummies since there may exist biases from firm, year, quarter, and industry specific characteristics.

Findings: Using 7,159 firm-year compensation data from ExecuComp, the authors find that the quality of analyst earnings forecasts improves when the proportion of equity compensation awarded to outside directors increases. They also separate equity compensation into stock and option. Their results show consistent improvement: more accurate and less dispersed analyst earnings forecasts. Overall, the findings suggest that the quality of analyst earnings forecasts is better when outside directors are compensated with equity compensation.

Research limitations/implications: This study provides empirical evidence of benefit from equity compensation of outside directors in line with existing compensation studies in accounting and finance literature. Unlike a majority of the extant studies, this study examines how the composition of director compensation affects the quality of information which financial analysts produce. Consistent with an argument that equity compensation aligns the interests, outside directors with more equity compensation tend to provide financial information with better quality, the authors document that analysts are likely to provide more accurate and less disperse information.

Practical implications: For and board members, this study offers an implication that equity compensation could contribute to enhancing their firms’ information environment. In addition, analysts could improve their forecasting performance by following firm monitored by outside directors remunerated with equity compensation. For investors who put much emphasize on the quality of firms’ financial information, the use of equity compensation can be a useful criterion in their investment decision.

Originality/value: This study provides empirical evidence of benefit from equity compensation in line with compensation studies in accounting and finance literature. Therefore, equity compensation can be a useful criterion in their decision makings for various parties, including analysts, regulators, and individual investors.

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