Can financial statement analysis beat consensus analysts’ recommendations?

We examine whether investors can exploit financial statement information to identify companies with a greater likelihood of future earnings increases and whether stocks of those companies generate 1-year abnormal returns that exceed the abnormal returns from following analysts’ consensus recommendations. Our approach summarizes financial statement information into a “predicted earnings increase score,” which captures the likelihood of 1-year-ahead earnings increases. We find that, within our sample of consensus recommendations, stocks with high scores are much more likely to experience future earnings increases than stocks with low scores. A hedge portfolio strategy that utilizes our approach within each consensus recommendation level generates average annual abnormal returns of 10.9 percent over our 12-year sample period, after controlling for previously identified risk factors. These abnormal returns exceed those available from following analysts’ consensus recommendations. Our results show that share prices and consensus recommendations fail to impound financial statement information that helps predict future earnings changes.     

Are banks using hidden reserves to beat earnings benchmarks? Evidence from Germany

Section 340f of the German Commercial Code allows banks to provision against the special risks inherent to the banking business by building hidden reserves. Beyond risk provisioning, these reserves are implicitly accepted as an earnings management device. By analyzing financial statements of German banks for the period 1997–2009, we see these hidden reserves being used to (1) avoid a negative net income, (2) avoid a drop in net income compared to the previous year, (3) avoid a shortfall in net income compared to a peer group, and (4) reduce the variability of banks’ net income over time. Our analysis also shows that if bank managers are unable to reach the targets as set out in (1)–(3), they are more inclined to keep the hidden reserves for use in future periods.     

How does competition affect real earnings management to meet or beat targets? Evidence from import tariff reductions

Targets provide incentives for earnings management, and a longstanding question is whether earnings management is undertaken opportunistically or to communicate private information about future firm value. To discriminate between these motivations, I follow analytical research showing that an increase in competition through a large decrease in tariffs disciplines managers and better aligns their interests with those of shareholders. Thus, if earnings management reflects managerial opportunism, then an increase in competition will decrease earnings management; and if it signals future performance expectations, then an increase in competition will increase earnings management. Consistent with earnings management indicating managerial opportunism, I show that an increase in competition decreases real earnings management to avoid reporting negative earnings or a negative change in earnings. In addition, by showing that the lessening of trade barriers through import tariff reductions reduces the use of real earnings management to meet or beat earnings targets, I provide evidence on the role of macroeconomic conditions as a determinant of earnings quality.     

Shifting corporate culture: executive stock ownership plan adoptions and incentives to meet or just beat analysts’ expectations

This paper investigates whether adoptions of executive stock ownership plans coincide with decreased incentives to meet or just beat analysts’ near-term EPS forecasts. Firms often assert that ownership plans focus executives on long-term performance. I find that the impact of these adoptions on meeting or just beating analysts’ EPS forecasts differs depending on whether the plan binds the CEO to reach ownership targets by a specified date. In particular, I find that firms that adopt plans requiring an increase in CEO ownership exhibit a lower propensity to meet or just beat earnings forecasts following plan adoptions. In contrast, firms that adopt plans that require no increase exhibit no change in the propensity to meet or just beat. The results suggest that firms use binding ownership plans to shift executives’ focus from near-term earnings benchmarks to long-term value creation.