Performance targeting—setting short-term financial goals—is pervasive in today’s financial markets, but it may come at a cost. HKUST’s Emilio Bisetti and a colleague explore how public banks strategically alter their deposit pricing strategies when they face pressure to meet earnings per share (EPS) targets.

“The general consensus is that, by encouraging managers to sacrifice investment in long-term value in favor of short-term outcomes, performance targeting has negative welfare consequences,” say the authors. Yet research has paid surprisingly little attention to the impact of performance targeting on product pricing, a critical firm decision with potential implications for consumers and competitors.

Filling this gap, the authors conduct the first systematic study of how public firms’ incentives to meet performance targets affect their product market behavior. Using a combination of economic theory and empirical analyses, they ask how U.S. alter their deposit pricing strategies when they feel under pressure to meet short-term financial goals.

“We show that public banks face negative stock return jumps after missing their EPS targets,” the authors report, “and theoretically and quantitatively link these jumps to bunching behavior in the EPS surprise distribution.” “Bunching” refers to the clustering of EPS surprises around zero, signaling that banks are manipulating their financial reporting or engaging in strategic behaviors to hit their EPS targets and avoid disappointing investors.

By lowering the interest rates they offer on deposits, banks can meet these targets and save money in the short run. However, this tactic can backfire, as customers may withdraw their funds to find better rates elsewhere. Competing private banks take advantage of this situation by raising their own deposit rates to attract those unhappy customers.

This important study not only provides “a new methodology to detect earnings management incentives” but also show how performance targeting can negatively impact customer retention and inform broader competitive dynamics, providing valuable insights for banks and regulators.