Management earnings forecasts and IPO performance: evidence of a regime change

Companies undertaking initial public offerings (IPOs) in Greece were obliged to include next-year profit forecast in their prospectuses, until the regulation changed in 2001 to voluntary forecasting. Drawing evidence from IPOs issued in the period 1993–2015, this is the first study to investigate the effect of disclosure regime on management earnings forecasts and IPO long-term performance. The findings show mainly positive forecast errors (forecasts are lower than actual earnings) and higher long-term returns during the mandatory period, suggesting that the mandatory disclosure requirement causes issuers to systematically bias profit forecasts downwards as they opt for the safety of accounting conservatism. The mandatory disclosure requirement artificially improves IPO share performance. Overall, our results show that mandatory disclosure of earnings forecasts can impede capital market efficiency once it goes beyond historical financial information to involve compulsory projections of future performance.     

Performance of Malaysian IPOs: Underwriters reputation and management earnings forecasts

This paper examines the financial performance of Malaysian initial public offerings (IPOs) during the period 1980–1995. The major focus of the study is on the role of management earnings forecasts and underwriters in the valuation of IPOs. The results suggest extremely high and statistically significant initial premiums and positive and statistically significant long-term returns up to 3 years after listing. The findings for long-term returns contradict the consensus of the IPO literature that documents a significant negative long-term performance. Our results indicate a negative association of upward bias in management earnings forecasts with IPOs' performance during the first 12 months after the IPOs.     

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.     

Long-run abnormal return after IPOs and optimistic analysts' forecasts

This empirical study examines whether the optimistic forecasts of analysts explain the long-run abnormal return following initial public offerings (IPOs). Consistent with prior research, this paper concludes that the analysis of earning forecasts for firms going public has an upward bias. While the usually calculated buy-and-hold abnormal return is not significantly negative on average, a proper control for risk confirms the long-run underperformance hypothesis for the 1-year period following IPOs. The risk-adjusted return is positively correlated to the surprise effect and earning forecast revisions, and appears to be the response to new information about the true earnings perspectives.     

Predicting Subsequent Management Forecasting Behavior at the Date of an Initial Public Offering

In this study, we examine the conditions and choices of firms at dates of initial public offerings (IPOs) as a basis for predicting their likelihood of management earnings forecast disclosure in post-IPO periods. Using a sample of 944 IPOs, we demonstrate that firms choosing to reduce IPO information asymmetries or signal issue quality by choosing prestigious underwriters, high quality auditors, and higher percentages of retained ownership tend to issue management forecasts in the post-IPO period. These relationships exist after controlling for IPO date measures of risk/stability, a construct that prior management forecast research has found to be a key determinant of the forecasting act.     

The association between qualitative management earnings forecasts and discretionary accounting in the Netherlands

This paper examines whether there is an association between discretionary accounting and the accuracy of long-run forecasts of annual earnings disclosed voluntarily by Dutch companies in the directors’ report. In particular, investigations were made of the consistency in the sign and direction of discretionary accounting techniques and qualitative earnings forecasts. Long-run forecasts are defined, for the purposes of this paper, as forecasts made at least seven months before the year-end. Although not mandatory, qualitative forecasts are released by well over 60% of the listed companies in the Netherlands. Empirical results indicate that there is consistency in the sign and direction of qualitative earnings forecasts and discretionary accounting. After adopting discretionary accounting, the forecast errors are reduced if the company can reach the management earnings forecast (target). In the event that reserves are insufficient to accomplish this goal, managers choose their next best option and take an earnings bath in order to maximize reserves available for future use. By partitioning the sample in various sub-sets it is shown that earnings management and forecast errors occur most in the extreme ranges of financial performance. Overall, the study shows that management engages in discretionary accounting to present results in line with the disclosed qualitative earnings forecasts in their directors’ reports. Whilst discretionary accounting may clearly improve the consistency of companies’ earnings forecasts released via the directors’ reports and the actual earnings, managers’ earnings forecasts are sometimes disclosed in anticipation of planned discretionary accounting actions.     

An Empirical Analysis of the Bias and Rationality of Profit Forecasts Published in New Issue Prospectuses

Our study sets out to assess the accuracy of profit forecasts made by IPOs in Hong Kong. We use a variety of measures and tests to examine the accuracy, bias, rationality, and superiority of earnings estimates. The results show that forecast accuracy compares favourably with the findings from the developed economies of Australia, Britain, Canada, and New Zealand. Forecasts are shown to be superior to the predictions from time series models. IPOs tend to underforecast in the sense that actual profits exceed the forecasts. The rationality tests show mixed results. Cross-sectional analyses of forecast accuracy have poor explanatory power although the Big Six reporting accountants are associated with smaller forecast errors.     

An Empirical Analysis of the Bias and Rationality of Profit Forecasts Published in New Issue Prospectuses

Our study sets out to assess the accuracy of profit forecasts made by IPOs in Hong Kong. We use a variety of measures and tests to examine the accuracy, bias, rationality, and superiority of earnings estimates. The results show that forecast accuracy compares favourably with the findings from the developed economies of Australia, Britain, Canada, and New Zealand. Forecasts are shown to be superior to the predictions from time series models. IPOs tend to underforecast in the sense that actual profits exceed the forecasts. The rationality tests show mixed results. Cross-sectional analyses of forecast accuracy have poor explanatory power although the Big Six reporting accountants are associated with smaller forecast errors.     

Narcissistic managers and IPO underpricing

Using hand-collected data on the signature size of managers in Chinese initial public offerings (IPOs) from 2007 to 2019 as a proxy for managerial narcissism, we examine how IPOs with narcissistic managers (narcissistic IPOs) affect IPO underpricing. The findings suggest that narcissistic IPOs have higher underpricing than non-narcissistic IPOs. Specifically, we find that on average, a narcissistic IPO exhibits approximately 11.3% higher underpricing than a median IPO firm. Our results are robust to alternative metrics of narcissism and underpricing after controlling for endogeneity. Additional analyses suggest that narcissistic IPOs are more likely to engage in earnings management than non-narcissistic IPOs. The former exhibits excessive risk-taking behavior, gauged by earnings volatility pre-IPO and a higher beta post-IPO. In the cross-sectional analyses, we document that the impact of managerial narcissism on IPO underpricing is more salient for IPOs facing unsophisticated investors, high market sentiment, or poor corporate governance.     

Do you really want to ask an underwriter how much money you should leave on the table?

This paper analyses whether the owners of companies seeking to list will leave less money on the table if underwriters are employed to price and market the issue. Our findings indicate that limited liability and Industrial company initial public offerings (IPOs) that have used underwriters have left more money on the table than those not employing underwriters. Not only is there a direct cost in employing an underwriter but this study suggests there might also be an indirect cost. We also find that a positive forecast earnings per share yield may be useful in reducing the amount of money left on the table.     

Earnings management and initial public offerings: Evidence from the Netherlands

This paper presents one of the first studies of earnings management by initial public offering (IPO) firms in a European country. Using a sample of 64 Dutch IPOs, we investigate the pattern of discretionary current accruals (DCA) over time. We find that managers manage their company's earnings in the first year as a public company but not in the years before the IPO. We also examine the impact of earnings management on the long-run stock price performance of IPOs. We find a negative relation between the size of the DCA in the first year as a public company and long-run stock price performance over the next 3 years. A number of additional tests support these findings.     

Earnings Management and the Long-Run Market Performance of Initial Public Offerings

Issuers of initial public offerings (IPOs) can report earnings in excess of cash flows by taking positive accruals. This paper provides evidence that issuers with unusually high accruals in the IPO year experience poor stock return performance in the three years thereafter. IPO issuers in the most "aggressive" quartile of earnings managers have a three-year aftermarket stock return of approximately 20 percent less than IPO issuers in the most "conservative" quartile. They also issue about 20 percent fewer seasoned equity offerings. These differences are statistically and economically significant in a variety of specifications.     

Evidence That Management Earnings Forecasts Do Not Fully Incorporate Information in Prior Forecast Errors

Abstract:  This paper investigates whether managers fully incorporate the implications of their prior earnings forecast errors into their future earnings forecasts and, if not, whether this behavior is related to the post-earnings announcement drift. I find a positive association in consecutive management forecast errors, suggesting that managers underestimate the future implications of past earnings information when forecasting earnings. I also find that managers underestimate the information in their prior forecast errors to a greater extent when they make earnings forecasts with a longer horizon. Finally, I find that, similar to managers, the market also underreacts to earnings information in management forecast errors, which leads to predictable stock returns following earnings announcements.     

Identifying Factors Consistently Related to Value Line Earnings Predictability

Earnings predictability can affect investment decisions and stock prices. An important source of earnings forecasts for a wide variety of empirical studies has been the Value Line Investment Survey. The purpose of this study is to identify factors that consistently account for cross-sectional differences in Value Line earnings predict-ability. A multivariate model consisting of four company variables and a set of industry indicator variables is used to evaluate the intertemporal consistency of factors related to earnings predictability. Quarterly and annual forecasts are used to measure earnings forecast accuracy. The results by year indicate that one factor, earnings variability, is consistently related to earnings predict-ability.     

Conflicts of Interest and Research Quality of Affiliated Analysts in the German Universal Banking System: Evidence from IPO Underwriting

The quality of equity research by financial analysts is a prerequisite for an efficient capital market. This study investigates the quality of earnings forecasts and stock recommendations for initial public offerings (IPOs) in Germany. The empirical study includes 12,605 earnings forecasts and 6,209 stock recommendations of individual analysts for the time period from 1997 to 2004. The focus of this study is on analysing the potential conflicts of interest that arise when the analyst is affiliated with the underwriter of an IPO. In a universal banking system these conflicts of interest are usually more pronounced and therefore interesting to investigate. The empirical findings for the German financial market suggest that earnings forecasts and stock recommendations of the analysts belonging to the lead-underwriter are on average inaccurate and biased, indicating some conflicts of interest. Moreover, the stock recommendations of the analysts that are affiliated with the lead-underwriter are often too optimistic resulting in a significant long-run underperformance for the investor. In contrast, unaffiliated analysts provide better earnings forecasts and stock recommendations that result in a superior performance for the investor.     

Forecasts in IPO Prospectuses: The Effect of Corporate Governance on Earnings Management

Prior research suggests that managers may use earnings management to meet voluntary earnings forecasts. We document the extent of earnings management undertaken within Canadian Initial Public Offerings (IPOs) and study the extent to which companies with better corporate governance systems are less likely to use earnings management to achieve their earnings forecasts. In addition, we test other factors that differentiate forecasting from non‐forecasting firms, and assess the impact of forecasting and corporate governance on future cash flow prediction. We find that firms with better corporate governance are less likely to include a voluntary earnings forecast in their IPO prospectus. In addition, we find that while IPO firms use accruals management to meet forecasts; the informativeness of the discretionary accruals depends on whether or not the firm would have missed its forecast without the use of discretionary accruals.     

On the Use of Intra-Industry Information to Improve Earnings Forecasts

We investigate whether earnings forecasts are improved by earlier earnings disclosures by firms in the same industry. We find improvements for time series forecasts, but not for analysts' forecasts. Considering prior earnings announcements reduces correlations between forecast errors and security price reactions to earnings announcements, even when incorporating these announcements improves forecast accuracy. Our explanation for this anomaly, which is supported by additional analysis, is that intra-industry information facilitates predicting transitory, rather than permanent, earnings components. The question of whether information transfers improve earnings forecasts provides the context for the analysis, but the primary contribution is the documentation of intra-industry information transfers in a setting other than capital markets.     

The role of accounting conservatism in management forecast bias

We investigate whether management earnings forecasts fully incorporate information in historical accounting conservatism. We find that management earnings forecasts are more optimistic for firms with greater accounting conservatism in the previous year. We further examine whether this conservatism-related optimistic bias in management earnings forecasts varies with managers’ difficulty predicting earnings accurately, managers’ opportunistic incentives, and the firms’ litigation risk. We find that the negative association between management forecast errors and conservatism increases, to various extent, with the firms’ operating cycles, earnings volatility, and the width of forecast range but does not change with proxies for opportunistic incentives or litigation risk. These results suggest that forecast difficulty is the primary reason for managers’ failure to incorporate conservatism fully in their earnings forecasts.     

The association between management earnings forecasts, earnings management, and stock market valuation: Evidence from French IPOs

This study investigates managers' motivations to engage in earnings management through purposeful interventions in the setting of discretionary accruals, in the context of initial public offerings (IPOs) in France. Firms issuing forecasts in their prospectuses are expected to differ from nonforecasters in the level of earnings management during the year following the public offering. Within the context of contracting theory, four research questions are addressed. First, are IPO firms issuing forecasts more inclined to manage earnings 1 year after an IPO compared to nonforecasting firms? Second, is a forecasting firm's level of earnings management conditioned by earnings-forecast deviation? Third, is earnings management by IPO forecasting firms affected by contractual and governance environments? Fourth, how do investors see through earnings management following IPO earnings forecasts, i.e., how do stock market participants value earnings components (i.e., nondiscretionary and discretionary accruals)? Our findings document that in the year following an IPO, the magnitude of earnings management is much higher for forecasters than for nonforecasters. Results also show that a firm's accrual behavior is affected by earnings-forecast deviation, but the relationship is moderated by contractual and governance constraints. Finally, it would appear that French investors do not adequately readjust the relationship between reported earnings and a firm's market value for the year in which earnings are subject to manipulations.     

The effect of Regulation FD on the properties of management earnings forecasts

We investigate Regulation FD’s (FD) effect on management earnings forecast properties. We posit FD’s prohibition on private manager-analyst communication reduces (increases) optimism (pessimism) in management earnings forecasts. Prior to FD, managers could avoid publicly retracting prior optimistic forecasts by privately communicating with analysts, who could lower investor expectations with a new analyst forecast. After FD, managers with optimistic forecasts must either publicly admit their optimism by issuing a new management forecast or they must negatively surprise investors at the earnings announcement. Further, FD forces managers to use public forecasts instead of private communications to establish beatable expectations. Our evidence suggests FD reduced optimism in management forecasts. This reduction in optimistic bias is not offset by an increase in pessimistic bias. Consistent with this, we further find post-FD improvements in forecast accuracy and informativeness. We find no such changes around several potentially confounding events or for foreign firms surrounding FD. Overall, our evidence suggests FD improved firms’ forecast properties (less bias, greater accuracy, and greater informativeness).