Feb 1, 2013

Man­ag­ing Man­agers’ Reputations

How man­agers’ con­cern for their rep­u­ta­tions influ­ences their dis­clo­sure of earn­ings forecasts

Based on the research of

Anne Beyer

Ronald A. Dye

Rep­u­ta­tion, rep­u­ta­tion, rep­u­ta­tion! O! I have lost my rep­u­ta­tion,” lament­ed Cas­sio in Shakespeare’s tragedy Oth­el­lo. I have lost the immor­tal part of myself, and what remains is bestial.”

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Mod­ern man­agers respon­si­ble for releas­ing infor­ma­tion about their com­pa­nies’ finances may put it less dra­mat­i­cal­ly. But many fear the dis­grace that results from a blow to one’s rep­u­ta­tion. Any­one even vague­ly famil­iar with U.S. cap­i­tal mar­kets knows that man­agers dis­play a con­sid­er­able con­cern for pro­tect­ing and enhanc­ing their rep­u­ta­tions for hon­esty and forth­right­ness while they are com­mu­ni­cat­ing with or trans­act­ing in these mar­kets,” says Ronald Dye, pro­fes­sor of account­ing infor­ma­tion and man­age­ment at Kel­logg School of Management.

Dye and Anne Bey­er, who received her PhD from Kel­logg in 2006 and is now an asso­ciate pro­fes­sor of account­ing at Stan­ford University’s Grad­u­ate School of Busi­ness, recent­ly exam­ined how eco­nom­ic incen­tives influ­ence man­agers in devel­op­ing and main­tain­ing a rep­u­ta­tion for being forth­com­ing. They cre­at­ed an eco­nom­ic mod­el that, Dye says, aims for a bet­ter under­stand­ing of how rep­u­ta­tion­al con­sid­er­a­tions affect the propen­si­ty of man­agers to issue earn­ings fore­casts and oth­er infor­ma­tion that is not required to be dis­closed in their firms’ finan­cial statements.”

More Flex­i­bil­i­ty than Expect­ed
The mod­el reveals that man­age­ment rep­u­ta­tions can some­times be a dou­ble-edged sword, as far as dis­clo­sure and oth­er mar­ket trans­ac­tions are con­cerned. Man­agers who have devel­oped strong rep­u­ta­tions for being forth­com­ing are not beyond exploit­ing those rep­u­ta­tions by avoid­ing, or delay­ing, the dis­clo­sure of infor­ma­tion that might put their com­pa­nies in a bad light.

Before his noto­ri­ous fraud became pub­lic, Bernie had a ster­ling rep­u­ta­tion among investors,” Dye recalls. That ster­ling rep­u­ta­tion is one of the rea­sons it was so easy for him to per­pet­u­ate the fraud, and also what allowed the fraud to get so big.”

Bernie Madoff’s long record of suc­cess on Wall Street as a wealth man­ag­er and invest­ment advis­er rep­re­sents an extreme exam­ple of how a manager’s rep­u­ta­tion can be exploit­ed. Before his noto­ri­ous fraud became pub­lic, Bernie had a ster­ling rep­u­ta­tion among investors,” Dye recalls. That ster­ling rep­u­ta­tion is one of the rea­sons it was so easy for him to per­pet­u­ate the fraud, and also what allowed the fraud to get so big.”

On the flip side, the mod­el pre­dicts that man­agers with a rep­u­ta­tion for with­hold­ing poten­tial­ly harm­ful infor­ma­tion will work hard to improve investors’ per­cep­tions of their rep­u­ta­tion. The mod­el estab­lish­es that one way man­agers can improve their rep­u­ta­tions with investors is to dis­close unfa­vor­able earn­ings fore­casts that have the poten­tial to reduce their firms’ cur­rent mar­ket val­ue in the short term. “ hen observ­ing an unfa­vor­able fore­cast, investors revise upwards their per­cep­tions of the prob­a­bil­i­ty the man­ag­er is forth­com­ing,” Bey­er and Dye report.

Forth­com­ing” and Strate­gic” Man­agers
The pair start­ed the project by devel­op­ing a sim­ple mod­el that dis­tin­guish­es between forth­com­ing” and strate­gic” man­agers. “ forth­com­ing man­ag­er dis­clos­es his earn­ings fore­cast when­ev­er he receives it,” they write in their paper, and a strate­gic man­ag­er dis­clos­es his earn­ings fore­cast only if it is in his self-inter­est to do so.” Investors are nev­er real­ly cer­tain which pro­file indi­vid­ual man­agers fit: there is always the pos­si­bil­i­ty that a man­ag­er can sur­prise investors — man­agers with flaw­less rep­u­ta­tions can behave bad­ly, or the con­verse. To account for such sur­pris­es, a manager’s rep­u­ta­tion is defined in terms of investors’ per­cep­tions of the prob­a­bil­i­ty that the manager’s dis­clo­sure is forth­com­ing or strate­gic. As investors observe the man­ag­er mak­ing — or not mak­ing — vol­un­tary dis­clo­sures over time, they will revise their assess­ments of the manager’s open­ness, thus deter­min­ing how his or her rep­u­ta­tion evolves.

The ini­tial mod­el assumed spe­cif­ic behav­ior on the part of strate­gic man­agers con­cerned about their rep­u­ta­tions. We expect­ed strate­gic man­agers to try to imi­tate the behav­ior of forth­com­ing man­agers and dis­close unfa­vor­able infor­ma­tion about their firms when they receive it, to con­vince investors that they are real­ly forth­com­ing man­agers,” Dye explains. But, of course, we did not expect strate­gic man­agers to always dis­close all bad infor­ma­tion they receive.”

Bey­er and Dye antic­i­pat­ed that strate­gic man­agers would adopt a cut­off” strat­e­gy: they would dis­close all infor­ma­tion they receive that is suf­fi­cient­ly good (in oth­er words, above the cut­off), but they would with­hold any infor­ma­tion worse than that. In this sort of set­ting, a strate­gic man­ag­er would man­i­fest a rep­u­ta­tion for being forth­com­ing by adopt­ing a low­er cut­off — that is, by dis­clos­ing a greater array of his unfa­vor­able infor­ma­tion — than would a strate­gic man­ag­er not con­cerned about his rep­u­ta­tion,” Dye says.

Fac­ing Real­i­ty
Real­i­ty turned out to be more com­pli­cat­ed. The prob­lem arose from our orig­i­nal­ly view­ing man­agers too sim­plis­ti­cal­ly, as either forth­com­ing all the time or strate­gic all the time,” Dye says. When we tried to make pre­dic­tions with the orig­i­nal mod­el, we found out that it some­times gen­er­at­ed incon­sis­tent behav­ior by man­agers. What we dis­cov­ered,” Dye recalls, was that strate­gic man­agers would some­times have an incen­tive to defy investors’ expec­ta­tions and devi­ate from what investors expect­ed them to do.” In par­tic­u­lar, the strate­gic man­agers would some­times dis­close infor­ma­tion just below the cut­off that the mod­el pre­dict­ed they would withhold.

That insight forced the pair to expand their view of the behav­ioral dif­fer­ences between forth­com­ing and strate­gic man­agers. Rather than a per­ma­nent and endur­ing fea­ture of a manager’s behav­ior, we start­ed think­ing about man­agers being more com­plex beings — strate­gic in some peri­ods and forth­com­ing in oth­ers,” Dye says. Not only does this more com­plex behav­ior fit with our intu­ition about man­agers’ actu­al dis­clo­sure behav­ior, but once we start­ed tak­ing this more expand­ed view of the dif­fer­ences between strate­gic and forth­com­ing man­agers, we found it easy to make the mod­el inter­nal­ly con­sis­tent. Also it allowed us to gen­er­ate a vari­ety of pre­dic­tions about how con­cerns for rep­u­ta­tion for­ma­tion affect man­agers’ dis­clo­sure behav­ior over time.”

Prin­ci­pal Pre­dic­tions
The expand­ed mod­el pro­duces five prin­ci­pal predictions:

  1. Con­cern for a rep­u­ta­tion may be so strong that a manger may vol­un­tar­i­ly dis­close adverse infor­ma­tion that he or she would not oth­er­wise reveal.
  2. When there is uncer­tain­ty about man­agers’ rep­u­ta­tions, there are always some man­agers who try to alter their rep­u­ta­tions by chang­ing their dis­clo­sure behavior.
  3. When there is uncer­tain­ty about man­agers’ rep­u­ta­tions, there are also always oth­er man­agers who make their dis­clo­sure deci­sions with­out any con­cern for the effect of their dis­clo­sures on their reputations.
  4. The impor­tance a man­ag­er attach­es to devel­op­ing a rep­u­ta­tion for being forth­com­ing varies depend­ing on how per­sis­tent his firm’s earn­ings are over time.
  5. The more investors are uncer­tain about man­agers’ rep­u­ta­tions, the less like­ly it is that strate­gic man­agers will try to imi­tate forth­com­ing managers.

In addi­tion to improv­ing our under­stand­ing of man­agers’ han­dling of their rep­u­ta­tions, the mod­el pro­duces prac­ti­cal advice. Most of these con­clu­sions were devel­oped as a guide to for­mu­late hypothe­ses about man­agers’ dis­clo­sure behav­ior that is sub­ject to empir­i­cal test­ing,” Dye says. But some of these results can also be the basis of guid­ing man­agers’ dis­clo­sure choic­es. For exam­ple, man­agers run­ning firms with earn­ings that are very per­sis­tent over time who want to devel­op a rep­u­ta­tion for being forth­com­ing will want to dis­close the infor­ma­tion they receive more aggres­sive­ly than man­agers of firms whose earn­ings are less persistent.”

Featured Faculty

Ronald A. Dye

Leonard Spacek Professor of Accounting Information & Management; Director, Accounting Research Center

About the Writer

Peter Gwynne is a freelance writer based in Sandwich, Mass.

About the Research

Beyer, Anne, and Ronald A. Dye. 2012. “Reputation Management and the Disclosure of Earnings Forecasts.” Review of Accounting Studies 17(4): 877–912.

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