Corporate Governance

The Influence of Top Managers on Voluntary Corporate Financial Disclosure

By Harvard Law School Program on Corporate Governance

Our paper, What?s My Style? The Influence of Top Managers on Voluntary Corporate Financial Disclosure, forthcoming in The Accounting Review, investigates two related research questions: (1) Do top managers exhibit unique and economically significant individual-specific styles in voluntary corporate financial disclosure? (2) If so, are observable characteristics of managers? personal backgrounds associated with any cross-sectional differences in their overall disclosure styles?

Prior theoretical and empirical research in economics, finance, and accounting generally posits a limited role for idiosyncratic manager-specific influences in explaining accounting and disclosure choices. In contrast, upper echelons theory, originating in the strategic management literature, suggests that differences among individuals can affect corporate outcomes, particularly in complex situations lacking clear solutions. Most of the prior research in voluntary disclosure follows the traditional financial economics perspective, yet even the most comprehensive empirical models leave most of the cross-sectional variation in disclosure unexplained. This prompts us to investigate whether these models are missing a major component: Do individual managers play a significant incremental role in voluntary corporate financial disclosure?

To address this question, we build a panel dataset that tracks top managers over time, which allows us to isolate manager-specific fixed effects. We find that top executives do significantly influence attributes of their firms? voluntary disclosure, even after controlling for economic determinants of disclosure identified in prior research, and firm-and time-specific effects.

We then investigate whether managers? unique disclosure styles are associated with observable characteristics of their own personal backgrounds. Building on upper echelons theory and a broad set of literatures ranging from strategic management, to career counseling, to sociology, to psychology, to military science, and to business education, we find that, on average: 1) managers promoted from legal backgrounds tend to guide expectations down (reflecting greater sensitivity to litigation risk) and managers promoted from accounting and finance develop more precise disclosure styles that are conservative in underestimating upcoming earnings, 2) managers born before World War II are more reluctant to forecast, 3) military experience leads managers to develop styles favoring more precise forecasts that guide expectations down, and 4) MBAs tend to guide expectations upward, but their forecasts are more accurate. These associations between our estimates of managers? fixed effects and distinctive permanent characteristics of their own personal backgrounds confirm that our estimated manager fixed effects reflect systematic long-lived differences in managers? unique disclosure styles.

Collectively, our evidence indicates that the heretofore largely unexplored ?people? dimension plays a significant incremental role in explaining cross-sectional differences in corporate voluntary disclosure, even after controlling for known economic determinants of disclosure, firm-specific effects, and time-period effects. Our evidence that managers not only matter, but matter significantly in seemingly second-order decisions such as the details of firms? voluntary disclosure decisions, extends the range of corporate decisions in which idiosyncratic manager styles are known to play an economically significant role. From a practical perspective, evidence that disclosures reflect manager-specific styles suggests that initiatives intended to remedy disclosure problems such as upward-biased forecasts may be more effective if they target the individual manager.

We believe future theoretical, archival, and experimental research incorporating richer roles for individuals? styles has great potential for increasing our understanding of how firms make financial reporting choices. However, significant further improvements in explaining managers? styles may require finer demographic data (than are currently publicly available), exploration of variables beyond demographic characteristics, and/or different research approaches.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on April 21, 2010 (boomark / email).