August 25, 2008

Letting the stock analysts drive the business

Bigger Isn’t Always Better describes how short-term stock prices are often poor measures of business performance. Excessive concern with them takes management’s eye off the real economics of the business, and often breeds failed growth strategies. One reason for this is that managing a company to stock analyst expectations delegates the business’ strategic direction away from management to Wall Street bystanders who have no real accountability for business performance.

Recently three Harvard Business School professors documented how this process of (mis-) influence works. Download their working paper (CEO and CFO Career Consequences to Missing Quarterly Earnings Benchmarks by Rick Mergenthaler, Shiva Rajgopal, and Suraj Srinivasan) via the link above to see the details. Here’s the short version:

"We find that missing quarterly earnings benchmarks, especially the analyst consensus earnings number, is associated with career penalties in the form of a reduced bonus, smaller equity grants, and a greater chance of forced dismissal for both CEOs and CFOs during the period 1993-2004.

These results are obtained after controlling for the magnitude of the earnings surprise, operating and stock return performance, and are significant in a statistical and in an economic sense.

Career penalties for failing to meet the analyst consensus estimate are higher for firms that give quarterly earnings guidance and in the post-SOX period. Our evidence suggests that (i) boards appear to react directly to managers' ability to meet earnings targets or to the information that is reflected in meeting such benchmarks; and (ii) senior managers' preoccupation with meeting earnings benchmarks might be based at least partly on career concerns."


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