Analyst reputation and management earnings forecasts

Prior studies show that analysts with high reputation are influential in the market. This paper examines whether managers consider analyst reputation in shaping their voluntary disclosure strategy. Using Institutional Investor magazine’s All-American (AA) rankings as a proxy for analyst reputation, we find that the coverage of AA analysts is positively associated with the likelihood of quarterly management earnings forecasts (MEFs). We also find that AA analysts’ forecast optimism is more positively associated with the likelihood of MEFs than non-AA analysts’ forecast optimism when the firm is covered by AA analysts. Analyses based on AA analyst coverage changes and AA status changes confirm the relation between analyst reputation and MEFs. We further find that analyst reputation influences other MEF properties, such as forecast news, bias, and revisions, and that our results are robust to alternative measures of analyst reputation. Further analyses show that market reactions at quarterly earnings announcements are more positive (negative) when firms meet/beat (miss) AA analysts’ forecasts than when firms meet/beat (miss) non-AA analysts’ forecasts. Collectively, our findings suggest that managers strategically provide voluntary forecasts by taking into account the reputation of individual analysts following their firms.     

Additional Evidence on Analysts’ Decision to Issue Disaggregated Earnings Forecasts: Strategic Biasing

This study examines why analysts issue disaggregated earnings forecasts to I/B/E/S. Some recent studies suggest that analysts with superior forecasting ability issue disaggregated earnings forecasts to build reputation in the marketplace and stop forecast disaggregation once their reputation has been established. Based on an analysis of I/B/E/S forecast data for U.S. firms from 1998 to 2008, we find that, in a given year, about 20%–34% of analysts disaggregate for some, but not for all the firms that they follow. This evidence of selective disaggregation by analysts suggests that reputation building alone does not fully explain the decision to disaggregate forecasts. We hypothesize that the decision to disaggregate earnings forecasts is at the firm‐level as well and is systematically related to the analysts’ bias in the issued forecasts. Our findings are that (a) analysts’ overall optimistic bias and forecast errors decrease monotonically with the level of forecast disaggregation, and (b) analysts that selectively disaggregate their forecasts for some firms or who do not persistently disaggregate a given firm's forecasts exhibit more positive bias and larger forecast errors. Our findings are consistent with the notion that the analysts who issue biased forecasts, for example, to curry favour with the management, are less likely to provide disaggregated information as part of the forecast.     

A re-examination of analysts’ superiority over time-series forecasts of annual earnings

We re-examine the widely held belief that analysts?? earnings per share (EPS) forecasts are superior to random walk (RW) time-series forecasts. We investigate whether analysts?? annual EPS forecasts are superior, and if so, under what conditions. Simple RW EPS forecasts are more accurate than analysts?? forecasts over longer horizons, for smaller or younger firms, and when analysts forecast negative or large changes in EPS. We also compare the accuracy of a third forecast of longer-term earnings based on a na?ve extrapolation of analysts?? 1-year-ahead forecasts. Surprisingly, this na?ve extrapolation provides the most accurate estimate of long-term (2- and 3-year-ahead) earnings. These findings recharacterize prior generalizations about the superiority of analysts?? forecasts and suggest that they are incomplete, misleading, or both. Moreover, in certain settings, researchers can rely on forecasts other than these explicit forecasts.     

Why Do Managers Explain Their Earnings Forecasts?

Managers often explain their earnings forecasts by linking forecasted performance to their internal actions and the actions of parties external to the firm. These attributions potentially aid investors in the interpretation of management forecasts by confirming known relationships between attributions and profitability or by identifying additional causes that investors should consider when forecasting earnings. We investigate why managers choose to provide attributions with their forecasts and whether the attributions are related to security price reactions to management earnings forecasts. Using a sample of 951 management earnings forecasts issued from 1993 to 1996, we find that attributions are more likely for larger firms, less likely for firms in regulated industries, less likely for forecasts issued over longer horizons, more likely for bad news forecasts, and more likely for forecasts that are maximum type. Furthermore, attributions are associated with greater absolute price reactions to management forecasts, more negative price reactions to management forecasts (forecast news held constant), and a greater price reaction per dollar of unexpected earnings. Our findings hold after control for the aforementioned determinants of attributions and after control for other firm‐ and forecast‐specific variables that are often associated with security prices.     

中国上市公司自愿业绩预告动机研究

随着业绩预告制度的实施和演进,我国资本市场上逐步出现了越来越多的上市公司自愿业绩预告,这对于缓解管理层与投资者、机构投资者与中小投资者之间的信息不对称具有重要意义。那么,是什么因素激励上市公司管理层自愿披露业绩预告?通过借鉴西方的自愿信息披露理论,并结合我国转轨经济的制度背景,本文提出了我国上市公司自愿业绩预告的三类动机:资本市场交易、管理层股票收益和管理层能力信号传递,并以2001-2008年我国上市公司业绩预告数据为研究样本对此进行了检验。研究结果显示,融资需求高、管理者利益协同程度高、会计业绩好的上市公司更有动机自愿披露业绩预告,并且国有相对于非国有上市公司自愿披露动机更弱。     

Accounting flexibility and managers’ forecast behavior prior to seasoned equity offerings

This study examines the effect of accounting flexibility on managers’ forecasting behavior prior to seasoned equity offerings (SEOs). Although SEO firms have a strong incentive to convey optimistic information to boost the pre-SEO stock price, they also face enhanced litigation risk arising from SEO-related regulations. Thus, I hypothesize that managers will release positive news through their forecasts (relative to the prevailing analyst consensus) prior to an SEO only if they have the accounting flexibility to manage subsequent reported earnings to meet or exceed their forecasts. I find that managers with greater accounting flexibility are more likely to issue a forecast prior to the SEO and that their forecasts are more likely to convey positive news and are more specific. Furthermore, I find no effect of accounting flexibility for non-SEO control firms or for non-SEO periods. My results suggest that when managers experience a tension between the incentive for voluntary disclosure and high litigation risk, accounting flexibility is an important factor that determines their forecasting behavior.     

The effect of stock price on discretionary disclosure

I examine the impact of exogenous changes in stock prices on voluntary disclosure. Specifically, I investigate whether stock price declines prompt managers to voluntarily disclose firm-value-related information (management forecasts) that was withheld prior to the decline because it was unfavorable but became favorable at a lower stock price. Consistent with my predictions, I find that managers are more likely to release good-news forecasts following larger stock price declines but that there is no association between the likelihood of releasing good-news forecasts and the magnitude of stock price increases. Additional evidence indicates that the good-news forecasts eventually conveyed by withholding firms after negative price shocks would likely have resulted in negative market reactions had they been released before the shocks. More generally, I provide evidence that managers withhold bad news and that exogenous stock price declines can induce its disclosure.     

Are Auditors Professionally Skeptical? Evidence from Auditors’ Going‐Concern Opinions and Management Earnings Forecasts

We examine whether auditors exercise professional skepticism about management earnings forecasts when making going‐concern decisions. Using publicly issued management earnings forecasts as a proxy for earnings forecasts provided by managers to auditors, we find that management earnings forecasts are negatively associated with both auditors’ going‐concern opinions and subsequent bankruptcy. The weight auditors put on management forecasts in the going‐concern decision is not significantly different from the weight implied in the bankruptcy prediction model. Moreover, compared with the bankruptcy model, auditors assign a lower weight to management forecasts they perceive as being less credible, including those (1) issued by managers who issued optimistic forecasts in the previous two years, and (2) predicting high earnings increases or high earnings. Taken together, our evidence is consistent with auditors being professionally skeptical about management earnings forecasts when making going‐concern decisions.     

Are more able managers good future tellers? Learning from Japan

Baik et al. (2011) find that high-ability managers in the U.S. are more likely to issue accurate management earnings forecasts. Focusing on Japan, where management earnings forecasts are effectively mandated, we extend the literature by exploring (1) whether the relationship between managerial ability and forecast accuracy is unique to the U.S. disclosure system, where management forecasts are voluntary, and (2) how high-ability managers increase their forecast accuracy. We find that managerial ability is negatively associated with forecast errors based on initial forecasts, suggesting that high-ability managers are more likely to issue accurate forecasts at the beginning of the fiscal year. We then show that high-ability managers are less likely to revise their initial earnings forecasts and less likely to use earnings management to improve the accuracy of their earnings forecasts. Our findings show that, while high-ability managers are more likely to issue accurate initial management forecasts, low-ability managers are more likely to revise their forecasts and conduct earnings management to reduce their forecast errors.     

The accuracy of earnings forecasts in IPO prospectuses on the Kuala Lumpur Stock Exchange

This paper examines the accuracy of earnings forecasts made by managers of Malaysian initial public offerings (IPOs) during the period 1984–1995. It is a mandatory requirement for Malaysian IPOs to furnish earnings forecasts together with the opinions thereon of the auditors and the lead underwriter in their prospectuses. Their accuracy is measured by forecast errors, absolute forecast errors, squared forecast errors and standardised forecast errors. The results suggest that, on average, managers under-forecast earnings by 33.37%. A comparison with the naive no change model in earnings suggests that 96 out of 122 companies outperform this model. A number of company specific characteristics (size, age, forecast interval, gearing, proportion of shares retained by owners, auditor reputation and industry) are tested. The results reveal that both the age and industry classification of the company are statistically significant, and that management earnings forecasts are particularly inaccurate where firms experience a decline in earnings. Key words: accuracy of prospectus earnings forecasts, initial public offerings, accounting in Malaysia.     

Analysts' Reactions to Earnings Preannouncement Strategies

Preannouncements of earnings tend to overstate negative or understate positive news, which decreases the chance of a negative surprise when actual earnings is announced. We conduct an experiment to investigate how experienced sell-side analysts' earnings forecasts are affected by preannouncements that either understate, accurately state, or overstate the magnitude of positive or negative total earnings news, holding total earnings news constant. We find that firms with negative (positive) total news receive the highest post-earnings announcement forecasts of future earnings when the earlier preannouncement overstates (understates) the magnitude of the news. These forecasts are consistent with the analysts' perceptions about the firms' future prospects, but not their perceptions of management. While analysts expect preannouncements to be lower than actual earnings, they do not adjust their forecasts for these beliefs. These insights into analysts' responses have implications both for managers and analysts.     

Regulation Fair Disclosure and the timeliness of long-horizon management forecasts

We examine the effect of Regulation Fair Disclosure (hereafter Reg FD) on the timeliness of long-horizon management forecasts of annual earnings, especially those conveying bad news. We expect that managers are less timely in issuing bad news forecasts than good news forecasts prior to Reg FD when they can disclose bad news to selected analysts and institutional investors privately. As Reg FD prohibits private disclosures of material information, managers are expected to accelerate the issuance of long-horizon bad news forecasts after Reg FD due to concerns of litigation risk from institutional investors and loss of analyst coverage, leading to a decrease in timeliness asymmetry between bad news and good news forecasts. We also expect that the effect of Reg FD is stronger among firms with lower ex-ante litigation risk or higher information asymmetry as they are more likely to withhold bad news prior to Reg FD. In addition, we expect that investors and analysts react more to bad news forecasts than to good news forecasts prior to Reg FD, and this asymmetry decreases after Reg FD. Our results are consistent with our predictions and suggest that managers provide long-horizon forecasts conveying bad news more timely after Reg FD.     

The association between quarter length,forecast errors,and firms’ voluntary disclosures

Approximately 60 percent of adjacent fiscal quarters contain a different number of calendar days. In preliminary analyses, we find the change in quarter length is significantly associated with the changes in sales and earnings and that analysts condition on the prior quarter's results when making their forecasts. These results indicate that it is important for analysts to adjust for changes in quarter length when making forecasts. However, we find the quarterly change in days is positively associated with analysts’ sales and earnings forecasts errors, where forecast error equals the actual earnings minus the forecasted earnings. These results indicate that analysts systematically underestimate (overestimate) performance when quarter length increases (decreases). We find evidence indicating investors make similar errors as returns around earnings announcements are positively associated with the change in quarter length, but only when changes in firm performance is more sensitive to changes in quarter length. Corroborating these findings, managers are more (less) likely to discuss quarter length during conference calls when quarter length decreases (increases). These results are consistent with managers’ strategic disclosure incentives. In summary, our evidence suggests analysts and investors fail to fully take account of the quasi-mechanical effect that quarter length has on firm performance and managers strategically alter their voluntary disclosures to take advantage of these failures.     

The Dog that Did Not Bark: Limited Price Efficiency and Strategic Nondisclosure

Theory posits that investors can rationally infer the implications of strategic nondisclosure for firm value, pressuring managers to disclose information voluntarily. This study documents that the lack of an earnings guidance predicts an abnormal return of −41 basis points around the subsequent quarterly earnings announcement, suggesting that investors do not fully incorporate the implications of nonguidance. Further analyses demonstrate that limitations in price efficiency, driven by investors' limited attention and short-selling constraints, explain the mispricing of nonguidance and are associated with less guidance issuance. Our results collectively highlight limited price efficiency as another friction when studying managers' strategic disclosure decisions.     

The informativeness of pro forma and street earnings: an examination of information asymmetry around earnings announcements

Using adverse-selection cost as a proxy for information asymmetry, we find evidence that non-GAAP earnings numbers issued by management (pro forma earnings) and analysts (street earnings) improve price discovery. First, information asymmetry before an earnings announcement is positively associated with the probability of a non-GAAP earnings number at the forthcoming earnings announcement. Second, the post-announcement reduction in information asymmetry is greater when managers or analysts issue non-GAAP earnings at the earnings announcement and when the magnitude of the non-GAAP earnings adjustment is larger. Our results suggest that earnings adjustments by analysts and managers increase the amount and precision of earnings information and help to narrow information asymmetry between informed and uninformed traders following earnings announcements. Alternatively, the findings may be attributable to characteristics of non-GAAP firms and overall better reporting quality for those firms rather than non-GAAP earnings disclosure per se.     

How Do Investors Interpret Announcements of Earnings Delays?

Unlike in the case of delays of 10‐K or 10‐Q filings, the SEC does not require managers to disclose delays of earnings announcements to the public. Thus, for companies that are unable to report earnings by their expected date, managers face a decision: remain silent or announce the delay. Prior research has investigated all earnings delays, whether or not they are accompanied by announcements of the delay announcement, and found that the market reaction is slightly negative, on average, for companies that allow their expected earnings dates to pass without disclosing results. It's not clear, however, whether this negative reaction was due to the absence of news or to the information contained in the announcements of the earnings delays. The authors' recent study documents that earnings delay announcements are associated with an average one‐day abnormal stock return of a negative 6%. This statistically as well as economically significant reduction in value is consistent with anecdotal evidence in the popular business press as well as predictions of disclosure theories, in particular the explanation that concerns about legal liability and managerial reputation motivate managers to disclose bad news. The study also shows that almost all managers who announce earnings delays attempt to influence the market reaction by disclosing the underlying cause. Finally, the study shows that the market reaction to earnings delay announcements is positively related to future earnings changes, consistent with the role of these disclosures in providing a signal of deteriorating financial performance.     

Meeting or Missing Earnings Benchmarks: The Role of CEO Integrity

This paper examines the role of CEO integrity in determining whether a company's earnings benchmarks will be met, beaten or missed. Prior literature provides evidence that managers have incentives for meeting or beating earnings benchmarks and are rewarded by the market for doing so (Lopez and Rees, 2002; and Skinner and Sloan, 2002). Managers also have incentives to miss their earnings targets for the benefit of a lower strike price on subsequent option grants (McAnally et al., 2008). A CEO's involvement in backdating is taken here as a measure of his or her integrity. This paper shows that CEO integrity significantly influences whether benchmarks are met or beaten. In other words, backdating CEOs are more likely to meet or narrowly beat all three earnings benchmarks examined in the paper: positive earnings, last year's earnings and analysts’ forecasts. At the same time, they are also less likely to narrowly miss a zero‐earnings benchmark. The results presented in this paper further validate the use of benchmark meeting/beating as a measure of earnings manipulation.     

An Empirical Analysis of Qualitative Management Earnings Forecasts

Despite efforts by the Securities and Exchange Commission (SEC) to encourage corporate disclosure of quantitative management earnings projections, only a small fraction of firms voluntarily do so. Instead of quantitative estimates, a large number of firms choose to disclose qualitative (verbal) assessments of their earnings prospects. This paper is a study of the information characteristics and the usefulness of this alternative form of forecast disclosure to investors. The study examines a sample of qualitative forecast statements from the 1979–1985 period and finds associations between these forecasts and percentage changes in realized earnings per share, the direction of financial analysts' forecast revisions following the disclosure of these forecasts, and abnormal stock returns on the date of their disclosure. These associations are, however, shown to be more significant for negative (bad news) than for positive (good news) forecasts.     

Managing News Coverage around Initial Public Offerings

We examine opportunistic behavior of initial public offering (IPO) firms in Taiwan where they are required to disclose their own earnings forecasts and are unrestricted in releasing news around the offerings. We find that prior to the offerings, IPO firms tend to report higher earnings, disclose inflated earnings forecasts, and manage more good news. News management, however, emerges as the most predominant factor in aftermarket stock prices. In particular, IPO firms have a strong preference for releasing good news related to strategy/policy that may simply provide a vision of a firm's future. Furthermore, the news releases are often forward-looking when they are positive about the firms but tend to be realized when they are negative. IPO firms also tend to engage in more window dressing activities before a larger sale of IPO shares from existing shareholders or a larger decline in insiders' holdings. Our analysis shows that managerial optimism cannot fully account for their behavior .     

Roundtable on Corporate Disclosure

In an article published in this journal two years ago titled "Just Say No to Wall Street," Harvard's Michael Jensen and The Monitor Group's CEO Joseph Fuller urged companies to put an end to what they called the "earnings guidance game." Instead of earnings forecasts, Jensen and Fuller recommended that companies provide investors with information about their strategic goals and value drivers, and about the risks associated with carrying out those goals and management's plans to manage those risks.
In this roundtable, a group of corporate executives, equity analysts, and academics explore the possibility that companies can increase their values by resisting the temptation to "manage" earnings, committing to expanded disclosure, and engaging investors in a more strategic dialogue. By establishing such a dialogue, companies may be able to break out of the current "bad equilibrium" in which markets distrust managers and managers distrust markets.