A Dark Side of Industry Tournament Incentives

Abstract

Top executives’ reputation and rewards from the managerial labor market are at least partly determined by the financial information their firms convey to the capital markets. We thus examine whether managerial labor market incentives influence firms’ choices in such information transmission and whether these choices subsequently affect future outcomes in the managerial labor market. Our findings are consistent with a strategic information distortion hypothesis. Specifically, CEOs facing greater labor market incentives are more likely to engage in strategic financial disclosure choices to inflate their firms’ reported performance and to meet or narrowly beat earnings benchmarks, thereby enhancing their reputation and upward mobility in the labor market. At the same time, these CEOs are more careful not to commit disclosure maneuvers that trigger financial fraud and restatements, which will severely damage their reputation and undermine their future career prospects. These empirical patterns portray a nuanced picture of how CEOs respond strategically to labor market incentives and career concerns in making financial disclosure decisions. We further show that these decisions affect managerial labor market outcomes; consistent marginal benchmark beating leads to higher compensation and greater mobility in the labor market for CEOs.