C-Suite Communications Impact Financial Disclosure
Abstract:In the world of finance, quantifying the "soft qualities" of CEOs is a fairly new trend. In this emergent literature, SMU Cox Accounting Professor Ke and co-authors focus on how the executive team and their communications affects corporate disclosure quality. Their study is a first to demonstrate that top executives, other than just the CEO and CFO, also play important roles in the management forecast process. This study also adds to the growing literature in finance on social networks.
In the world of finance, quantifying the "soft qualities" of CEOs is a fairly new trend. In this emergent literature, Accounting Professor Ke and co-authors focus on how the executive team and their communications affects corporate disclosure quality. Their study is a first to demonstrate that top executives, other than just the CEO and CFO, also play important roles in the management forecast process.
"Recently, more research papers are using biographical information on CEOs, top executives, or directors," says Ke. "People are always interested in CEOs." Ke believes that the power of the CEO has been growing over time, which manifests in higher compensation. "While CFOs and other executives' salaries have grown, CEO salaries have probably risen more," he adds.
This study also adds to the growing literature in finance on social networks. A number of recent studies examine the roles of social connections between firms and mutual fund managers, analysts, and banks. But Ke and co-authors are among the first few to investigate how social connections within the firm impact corporate behavior. Little is known about how communication within the executive team affects the disclosure quality of firms.
Communication among executives can be an important part of disclosure quality because information is often dispersed within the firm and costly to transfer, notes research dating back to 1937. Top executives may have to rely on each other to collect, interpret, and communicate information before they consolidate it into disclosed information, especially when the information is forward-looking and difficult-to-verify.
Ke offers an example of forward-looking or hard-to-verify information. "Consider the release of the new iPhone. In order to forecast the performance of Apple after the release, the CEO or CFO of Apple has to communicate with the executives in charge of the marketing and supply chain, in order to gather information on the demand as well as the supply of new iPhones. This information is forward-looking and difficulty-to-verify. In this case, effective communication among the executive team helps reduce the noise in the information exchange, and therefore helps improve the accuracy of management forecasts."
The authors used a database that provides biographical information on boards of directors and senior company officers from 2001 to 2011. They then constructed a connection index based on educational and work connections between CEO and CFO, between CEO and other top executives, and between CFO and other top executives. Sociology studies show that when two parties share similar backgrounds, they tend to communicate more effectively; they have more frequent contact, a greater level of trust, and better mutual understandings. "Connection is our measure of communication quality," notes Ke. " Executives have higher connections, for example, if they are alumni, or have worked together before the current firm under analysis. It is easier to communicate with someone from the same university or with similar work experience, right?"
The authors apply the "connectedness" attribute to how the communications between top executives affects disclosure quality in terms of management guidance. "Management guidance" or voluntary disclosure relies more on forward-looking and hard-to-verify information. Ke explains, "Each quarter, managers will tell investors what they will do for the next quarter or whole year. They forecast earnings of firms and their earnings per share." The firm’s different departments provide information about its operations, financing, and investment activities to form accurate forecasts.
Today information about firms is more widely available on company websites. You can review earnings call transcripts, new deals via press releases and investor relations presentations. Both CEOs and other executives answer questions during conference calls, as they each specialize in, and possess information about different aspects of the firm's operations and therefore performance. Ke noted that pre-Internet, firms transferred information through analysts and intermediaries. "Over time, firms tend to disclose more information," Ke observes, " but it is hard to know whether this is because of regulation, technology changes, litigation risk, or other reasons."
The authors use prior social connections among top executives as a proxy for the effectiveness of their communication. They find that more connections are significantly associated with higher guidance accuracy, and that the association is stronger in environments with greater uncertainty (where communication is likely to be more important). Additional analyses suggest that top executives other than CEOs and CFOs hold information relevant to guidance, and CEOs are relatively more important than CFOs in the communication process.
Ke explains the findings: "We have firms where CEOs and top executives are connected and where they are not. In the firm where top executives are connected, management guidance will be 10% more accurate." Results imply that the effectiveness of the CEO’s communication with other top executives plays a particularly important role in forecast accuracy. Furthermore, this result also suggests that top executives other than the CEO and CFO possess information relevant to management forecast.
"We looked at whether communication impacts guidance accuracy more in the uncertain environment," Ke states. "It actually corroborated the evidence for our main finding: When firms face more uncertainty, communication becomes more important in improving the accuracy of management forecasts."
Does firm size matter in its ability to forecast more accurately? Ke offers that, "usually larger firms are better at forecasting their performance because they are more mature and stable. They should be forecasting their earnings better than smaller firms."
Many papers focus on CEOs and how they impact firms. But surprisingly little have focused on the executive team — how their communication shapes and impacts information disclosure. Ke notes that accounting research has tended to focus mainly on the CEO and CFOs. This first study reveals that other executive roles, such as the chief technology officer or chief marketing officer, can have an impact on the information quality of the firm too.
The paper "How Does Communication within the C-Suite Affect Management Forecast Accuracy? by SMU Cox School of Business Accounting Professor Ruihao Ke,
Meng Li of University of Texas (Dallas), Zhejia Ling of Iowa State University, and Yuan Zhang of University of Texas (Dallas) is under review.
Written by Jennifer Warren.