Long horizon institutional investors and the relation between missing quarterly analyst forecasts and CEO turnover

• Date: 07 May 2019
• Pages: 190-223
• Published date: 07 May 2019
• DOI: https://doi.org/10.1108/IJAIM-05-2017-0069
• Author: Juan Wang
• Subject Matter: Accounting & Finance,Accounting/accountancy,Accounting methods/systems

Long horizon institutional

investors and the relation between

missing quarterly analyst

forecasts and CEO turnover

Juan Wang

School of Economics and Business, SUNY Oneonta, Oneonta, New York, USA

Abstract

Purpose –The purpose of this paper is to investigatethe effect of long horizon institutional ownership on

CEO career concernsto meet the short-term earnings benchmark.

Design/methodology/approach –Using a sample of 10,565 firm-year observations in the USA, the

paper examinesthe extent to which long horizon institutional investors mitigatethe positive relation between

CEO turnoverand missing the quarterly consensus analystforecast.

Findings –After controlling for the general performance-turnover relation, this paper finds that long

horizon institutionalinvestors mitigate the positive relation betweenCEO turnover and missing the quarterly

consensus analystforecast. This finding is stronger when CEOs focus on long-termvalue creation and do not

sacrifice long-term value to boost current earnings and is stronger when the monitoring intensity by long

horizon institutionalinvestors is greater.

Research limitations/implications –The results suggest that long horizon institutional investors

serve a monitoringrole in alleviating CEO career concerns to meet the short-termearnings benchmark.

Originality/value –This paper contributes to the literature on the relation between long horizon

institutional ownership and attenuated managerial short-termism. The literature is silent about why long

horizon institutional investors alleviate managerial short-termism. This paper fills this voidin the literature

by documenting that long horizoninstitutional investors mitigate CEO career concerns for managerialshort-

termism. Moreover,this paper contributes to the literature on the monitoringrole of institutional investors by

documenting the incrementaleffect of institutional ownership on CEO career concerns to meet the short-term

earningsbenchmark.

Keywords Monitoring, CEO turnover, CEO career concerns, Long horizon institutional investors,

Missing the quarterly consensus analyst forecast

Paper type Research paper

1. Introduction

The adverse consequence of managerial short-termism has attracted increasing attention

from regulators, practitioners and researchers in the past couple of decades[1]. Managerial

short-termism refers to managers sacrificing long-term value (e.g. cuttingR&D) to meet the

short-term earnings benchmark (Porter, 1992). The survey evidence in Graham et al. (2005)

further suggests that career concerns appear to be a more important incentive than

compensation motivationthat drives managers to meet the short-termearnings benchmark.

Prior literature suggests that the monitoring by long horizon institutional investors can

alleviate managerialshort-termism (Porter, 1992;Bushee,1998, 2001;Wahal and McConnell,

2000;Burns et al., 2010;Aghionet al.,2013). However, what prior work leaves unclear is why

managerial short-termism is mitigated when long horizon institutional investors hold high

levels of ownership in the firms. Moreover, it is important to examine the effect of

IJAIM

27,2

190

Received26 May 2017

Revised31 July 2017

13September 2017

Accepted18 October 2017

InternationalJournal of

Accounting& Information

Management

Vol.27 No. 2, 2019

pp. 190-223

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-05-2017-0069

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/1834-7649.htm

institutional monitoring on boards’decisions –institutional ownershipof corporate equities

has grown steadily since the 70s and has exceeded 62 per cent by the end of 2009 (Burns

et al.,2010).

This study fills this void in the literature. In this study, I focus on CEO career concerns

and examine the relation between long horizon institutional ownership and CEO career

concerns to meet the short-term earnings benchmark. Specifically, I examine to what extent

long horizon institutional investors attenuate the relation between the likelihood of CEO

turnover and missing the quarterlyconsensus analyst forecast[2]. The implication is that by

attenuating career penalty when CEOs fail to meet the quarterly analyst forecast, long

horizon institutional investors alleviate CEOs’career concerns to meet the short-term

earnings benchmark.

Long horizon institutions are characterized as investors with long investment horizon

(i.e. relationship investing) and with large equity positions (Bushee,1998, 2001). Long

horizon institutionalinvestors typically consist of private banks, pensionfunds, foundations

and endowments (Ramalingegowda, 2014)[3]. Long horizon institutional investors have an

incentive to serve a monitoring role in influencing boards’decisions because of their large

ownership stakes in the firms. Theliterature on monitoring has long emphasized that costly

monitoring by institutions will be observed only when the benefits are sufficiently

concentrated to offset the costs (Shleifer and Vishny, 1986;Black and Coffee, 1994;Parrino

et al.,2003;Hartzell and Starks, 2003;Bushee et al., 2014). Following prior research (Ke and

Petroni, 2004;Ramalingegowda,2014), I use Bushee (1998,2001)“dedicated”institutions as

a proxy for long horizon institutionalinvestors[4].

Despite the literature support for the hypothesis, it is plausible that I fail to detect the

effect of long horizon institutional investors there. First, the dismissal of a CEO is

an extreme form of punishment (Matsunaga and Park, 2001) and does not happen

often (Demerjian et al., 2012); second, as discussed in Brickley (2003), the relation

between performance and CEO turnover appears to be low. Therefore, it is an empirical

question whether long horizoninstitutional investors affect the relation between missing the

quarterly consensusanalyst forecast and CEO turnover.

Using a sample of 10,565 firm-year observations that include 175 forced CEO turnovers

over the 1992-2005 period, I find a positive relation between the likelihood of CEO turnover

and missing the quarterly consensus forecast, after controlling for stock returns, industry-

adjusted change in return on assets, CEO age, CEO stock ownership, firm size and book-to-

market. This result suggests that the board imposes an incremental career penalty on the

CEO for missing the quarterly forecast beyond a normal penalty for poor performance

(Dikolli et al., 2014;Mergenthaler et al.,2012). Moreover, prior studies suggest that this

positive miss-turnover relationis more consistent with the board myopically fixating on the

short-term forecast benchmark than the board efficiently contracting with the CEO on

expected performance (Mergenthaler et al., 2012;Jensen, Murphy and Wruck, 2004;Fuller

and Jensen, 2010)[5].

More importantly, consistent with the hypothesis, I find that dedicated institutional

investors alleviate the positive relation between missing the quarterly forecast decreases

and the likelihood of CEO turnover. This result holds after controlling for the general

performance-turnover relation, CEO age, CEO stock ownership, firm size and the book-to-

market. This result suggests that dedicated institutional investors alleviate CEO career

concerns to meet the quarterly forecast benchmark.In terms of economic significance, each

miss increases the turnover probability by 2 per cent for firms with high dedicated

institutional ownership (above the sample median). In contrast, each miss increases the

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turnover probability by 32 per cent for firms with low dedicated institutional ownership

(below the sample median)[6].

The finding is robust to the two-stage least squares (2SLS) procedure, which

alleviates the endogeneity concern that the finding is driven by dedicated institutional

investors being attracted to firms with a more stable turnover policy (i.e. lower

sensitivity of turnover probability to missing the forecast). In addition, I find that the

attenuated miss-turnover sensitivity helps the CEO improve firm performance in the

future. This speaks to the economic benefits of alleviating the miss-turnover sensitivity

by dedicated institutional investors.

I conduct several cross-sectionalanalyses to reinforce the main results.Specifically, I find

that the moderating effect of dedicated institutional ownership on the miss-turnover

sensitivity is stronger when CEOs focus on long-term value creation and do not sacrifice

long-term value to boost current earnings (i.e. CEOs do not cut discretionary expenditure

such as R&D and advertising or overstate discretionary accruals to boost current

earnings)[7]. Further,I find that the moderating effect of dedicated institutional ownership is

stronger when the monitoring intensity by dedicated institutional investors is greater (i.e.

proxied by dedicated institutionalinvestors with larger stakes in the firms).

This paper contributes to the literatureon the relation between long horizon institutional

ownership and attenuated managerial short-termism. Overall, the literature suggests a

moderating effect of long horizon institutional ownership on managerial short-termism,

including the moderating effect on managerial incentive to engage in myopic investment

behavior to boost current earnings(Porter, 1992;Bushee, 1998;Wahal and McConnell, 2000),

the moderating effect on managerial incentive to overweight short-term earnings in pricing

firms (Bushee, 2001), the moderating effect on managerial incentive to overstate current

earnings (Burns et al.,2010) and the moderating effect on managerial incentive to

underinvest in long-term innovative projects (Aghion et al., 2013). However, prior literature

is silent about why long horizon institutional investors alleviate managerial short-termism.

This study fills this void in the literature by documenting that long horizon institutional

investors alleviateCEO career concerns for managerialshort-termism.

I also add to the literature on the monitoring role of institutional investors. Extant

literature has provided limited evidence concerning the effect of institutional monitoring on

boards’decisions (Hartzelland Starks, 2003). Moreover, prior studies primarily focus on the

effect of institutional monitoring on executive compensation and find that institutional

monitoring influences the pay-for-performance sensitivity and level of compensation

(Hartzell and Starks, 2003;Almazan etal., 2005;Dikolli et al.,2009;Shin, 2011)[8]. I note that

compensation contracts and career concerns affect managerial incentive to meet the short-

term earnings benchmark through different channels. While executive compensation is an

explicit and financial incentive, career concerns are an implicit and non-financial incentive

(Matsunaga and Park, 2001). The survey evidence in Graham et al. (2005) indicates that

career concerns appearto be a more important incentive for managers to meet the short-term

earnings benchmark than compensation schemes. Hence, this study complements prior

literature on the effect of institutional monitoringby providing evidence on the incremental

effect of institutional ownership on CEO career concerns to meet the short-term earnings

benchmark.

The remainder of the paper is organized as follows. Section 2 develops the

hypotheses. Section 3 discusses the sample and the data. Section 4 presents the

empirical methodology. Section 5 reports the main analyses and the cross-sectional

tests. Section 6 conclusions.

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