Hidden Gems: Do Compensation Disclosures Reveal Performance Expectations?

We find that a new compensation disclosure item on expected payouts from performance-based stock grants contains incremental information of a firm’s future performance. Firms that disclose the most optimistic expected payment significantly outperform over the next two years, while the least optimistic firms underperform. Investors and analysts are slow to process the embedded information and are later surprised around earnings announcement days. A portfolio long stocks of the most optimistic firms and short the least optimistic ones earns significant positive post-disclosure abnormal returns. The result is more pronounced when the embedded “soft” information differs from the more visible earnings news.