Stock market response to analysts' perceptions and earnings in a technology-intensive environment

This paper investigates the contemporaneous stock market response to financial analysts' perceptions of the firm and accounting earnings in the telecommunication and electronics industry in Finland. Analysts' perceptions used in the study are based on the Most Admired Companies survey similar to that conducted by Fortune magazine in the United States. The results indicate the nonfinancial information of the firm measured in terms of the analysts' perceptions has value relevance in a technology-oriented stock market.     

Anticipation of quarterly earnings announcements: A test of option market efficiency

This study tests Chicago Board Options Exchange efficiency by examining option price behavior in the weeks surrounding a firm's quarterly earnings announcement. The evidence presented here suggests that a first-order autoregressive seasonal process describes quarterly earnings behavior and demonstrates that the information content of an earnings announcement is fully incorporated in option prices by the end of the announcement week.     

Rational expectations,analysts' forecasts of earnings and sources of value gains for takeover targets

Value gains to target firm shareholders in takeover bids may be due to potential synergy between bidder and target and/or potential target restructuring based on new information released by the bid. Since these two models have different implications for the anticipated earnings of the target as a stand-alone entity, analysts' earnings forecast revisions (AFR) for the target during the bid may provide evidence for the new information hypothesis. For 326 UK targets of takeover bids during 1987–1993, we estimate analysts' earnings forecast revisions using the Institutional Brokers Estimate System (IBES) and relate them to bid premia paid to target shareholders. Analysts revise their forecasts significantly up on bid announcement. For failed, especially failed hostile, bids, the earnings forecast revision and bid premium are more positively correlated than for successful and friendly bids. This is consistent with the rational expectations behaviour of target shareholders modelled by Grossman and Hart [S.J. Grossman, O.D. Hart, Bell Journal of Economics 11(1) (1980) 42; S.J. Grossman, O.D. Hart, Journal of Finance 36 (1981) 253].     

Natural disasters and analysts' earnings forecasts

The effects of natural disasters on capital markets have been investigated by limited evidence even though these calamities bring considerable damages or loss of life. To fill this gap, we investigate the impacts of natural disasters, particularly earthquakes, on security analysts' earnings forecasts for affected firms in China. We obtain three key findings. First, analysts' optimism significantly decreases for firms located in neighborhood areas. Second, earthquakes do not significantly affect firm earnings and stock returns, thereby indicating that post-earthquake analyst pessimism is not based on rational judgment. Third, media attention promotes irrational pessimism among analysts, and post-earthquake pessimism is a result of heuristics bias attributable to psychological shocks. However, analysts correct the bias after initial irrational forecasts. Taken together, our findings contribute to the broader psychology and economics literature on the effects of natural disasters on analyst forecasts.     

Real earnings management and the properties of analysts' forecasts

Prior literature generally finds analysts are able to identify and process complex financial information. However, research suggests that in certain settings, analysts struggle to fully incorporate into their forecasts all available information. We examine analysts' forecast properties in the face of a specific type of complex financial information: real earnings management (REM). First, we investigate the relation between measures of REM and analysts' forecast properties. We find REM measures are associated with greater forecast error and dispersion in the following year. However, REM measures, by definition, capture abnormal operating results, and thus include both firms engaging in manipulative REM as well as firms experiencing firm-specific economic shocks. Thus, we conduct cross-sectional tests of analysts' forecasts for firms with and without incentives to manipulate earnings. We find that firms with low incentives to engage in earnings management (i.e., firms most likely experiencing firm-specific economic shocks) generate the strongest positive relation between REM measures and the following year's analysts' forecast properties, suggesting analysts more fully incorporate the earnings implications of firms with high incentives (i.e., firms most likely engaging in manipulative REM). Our results are consistent across numerous REM proxies and indicators of earnings management incentives.     

Understanding analysts' use of stock returns and other analysts' revisions when forecasting earnings

We investigate analysts' use of stock returns and other analysts' forecast revisions in revising their own forecasts after an earnings announcement. We find that analysts respond more strongly to these signals when the signals are more informative about future earnings changes. Although analysts underreact to these signals on average, we find that analysts who are most sensitive to signal informativeness achieve superior forecast accuracy relative to their peers and have a greater influence on the market. The results suggest that the ability to extract information from the actions of others serves as one source of analyst expertise.     

Lead indicator models and UK analysts' earnings forecasts

This study examines the predictive ability of models which adjust random walk forecasts of corporate earnings, to incorporate past changes in economic lead indicators. The results suggest that changes in the broad money supply measure M4 contain predictive ability, beyond equivalent changes in other lead indicators or an individual firm's earnings. When forecasts from the broad-money model are compared with forecasts generated by financial analysts a size effect is evident: the superiority of analysts' forecasts is apparent much earlier for large firms than for small firms. This result is consistent with studies suggesting a size-related differential in the collection and dissemination of information by market participants.     

Underwriting relationships,analysts' earnings forecasts and investment recommendations

We examine the effect of underwriting relationships on analysts' earnings forecasts and recommendations. Lead and co-underwriter analysts' growth forecasts and recommendations are significantly more favorable than those made by unaffiliated analysts, although their earnings forecasts are not generally greater. Investors respond similarly to lead underwriter and unaffiliated `Strong buy' and `Buy' recommendations, but three-day returns to lead underwriter `Hold' recommendations are significantly more negative than those to unaffiliated `Hold' recommendations. The findings suggest investors expect lead analysts are more likely to recommend `Hold' when `Sell' is warranted. The post-announcement returns following affiliated and unaffiliated analysts' recommendations are not significantly different.     

Is there an association between director option compensation and the likelihood of misstatement?

Oversight bodies in the United States (US) have addressed the issue of director independence in recent years. Bebchuk et al. [Bebchuk, L., Grinstein, Y., Peyers, U. (2006). Lucky directors. (Working paper Harvard University Law School) SSRN # 952239.] found that director oversight may be impaired if directors receive option grants under favorable terms because these grants may create a mutuality of interest between directors and managers. We assess whether option grants to independent directors reduce oversight of financial reporting. Using a sample of 105 US firms that misstated their revenue matched with a sample of non-misstatement firms, we find that companies whose independent directors do not receive stock options are less likely to misstate revenues than companies who meet the Sarbanes-Oxley definition of independence. Our results show that compensating outside directors with stock options may weaken their independent oversight.     

Block trading and information revelation around quarterly earnings announcements

I investigate the empirical importance of information revelationin the pricing of block trades. In particular, I examine whetherblock prices are correlated with the unexpected part of firms'quarterly earnings. For my sample of block trades, informationrevelation does indeed appear to be a significant factor shortlybefore earnings announcements.     

Alternative adjustments to analysts' earnings forecasts: relative and complementary performance

This study examines the relative and complementary performance of alternative earnings forecast adjustments using a common set of consensus analysts’ earnings forecasts. We document that a simple adjustment to analysts’ earnings forecasts, based solely on cross-sectional relationships between actual and forecasted earnings in the prior year, performs as well as more complicated adjustment methods, i.e., composite forecasts and persistence adjusted forecasts. A forecast adjustment that is based on prior year earnings and returns, however, provides significant incremental reductions in forecast error and dominates all of the other adjustment methods.     

Disclosure timing: Determinants of quarterly earnings release dates

Existing research on discretionary disclosures provides valuable insights on the potentials causes and consequences of alternative forms of disclosure. However, relatively little is known about how managers choose to time the release of financial information. This paper focuses on the quarterly earnings release dates and investigates why some choose to release earnings information relatively early, compared to others. The results indicate that the reporting lag (days between fiscal period end and quarterly earnings release date) is shorter for firms facing greater demand for information from investors and greater litigation costs. The reporting lag, however, is longer for firms with greater block ownership and those whose operations are somewhat more complex.     

The contextual nature of the predictive power of statistically-based quarterly earnings models

We present new empirical evidence on the contextual nature of the predictive power of five statistically-based quarterly earnings expectation models evaluated on a holdout period spanning the twelve quarters from 2000–2002. In marked contrast to extant time-series work, the random walk with drift (RWD) model provides significantly more accurate pooled, one-step-ahead quarterly earnings predictions for a sample of high-technology firms (n = 202). In similar predictive comparisons, the Griffin-Watts (GW) ARIMA model provides significantly more accurate quarterly earnings predictions for a sample of regulated firms (n = 218). Finally, the RWD and GW ARIMA models jointly dominate the other expectation models (i.e., seasonal random walk with drift, the Brown-Rozeff (BR) and Foster (F) ARIMA models) for a default sample of firms (n = 796). We provide supplementary analyses that document the: (1) increased frequency of the number of loss quarters experienced by our sample firms in the holdout period (2000–2002) vis-à-vis the identification period (1990–1999); (2) reduced levels of earnings persistence for our sample firms relative to earnings persistence factors computed by Baginski et al. (2003) during earlier time periods (1970s–1980s); (3) relative impact on the predictive ability of the five expectation models conditioned upon the extent of analyst coverage of sample firms (i.e., no coverage, moderate coverage, and extensive coverage); and (4) sensitivity of predictive performance across subsets of regulated firms with the BR ARIMA model providing the most accurate predictions for utilities (n = 87) while the RWD model is superior for financial institutions (n = 131).

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Trading volume in options and common stock around quarterly earnings announcements

This study examines trading in call and put options around quarterly earnings announcements and investigates whether the existence of these options affects the common stock trading volume response to these announcements. We find that the options trading volume reaction to earnings announcements is larger than the corresponding reaction in common stock. Consistent with the idea that options provide an alternative vehicle for trading on information, the existence of these options lowers the level of trading in common stock. Options also appear to offer investors an alternative method of taking short positions, as shown by the symmetric stock market trading volume reaction to good versus bad news for firms with listed options. In contrast, firms without listed options exhibit a larger trading volume response to good news than to bad news of similar magnitude.     

Consistency in meeting or beating earnings expectations and management earnings forecasts

This paper provides evidence that firms that have consistently met or beaten analysts’ earnings expectations (MBE) provide more frequent “bad news” management forecasts than firms with no established string of MBE, particularly when existing analyst forecasts are optimistic. This suggests that firms with a consistent MBE record are more likely to guide analysts’ expectations downward to avoid breaking the consistency. Subsequent analyst forecast revisions following bad news management forecasts issued by these firms are dampened, implying that analysts suspect that these forecasts may be opportunistic. The relation between management forecasts and MBE consistency is stronger after Regulation FD.     

Effect of foreign GAAP earnings and Form 20-F reconciliations on revisions of analysts' forecasts

A controversial area of U.S. securities regulations involves the Securities and Exchange Commission's (SEC) financial reporting requirements for foreign firms, specifically, the necessity of providing a quantitative reconciliation to U.S. GAAP (Form 20-F). The results of earnings-returns research to date indicate that the release of foreign GAAP earnings provides important information. However, the results of earnings-returns studies using reconciled information are mixed. Instead of using an earnings-returns methodology adopted in prior research, this study utilizes analysts' revisions as a market indicator of the effect of information released in foreign GAAP earnings and the reconciled information in Form 20-F. Additionally, the study investigates the influence of four firm-specific variables in the firm's information environment—similarities of accounting systems, analyst following, difference between reconciled earnings and foreign GAAP earnings, and dispersion of analysts' expectations—on positive abnormal revision activities of financial analysts at the time of filing Form 20-F.The results indicate that the release of foreign GAAP earnings (at earnings announcement dates) and reconciled information (at the time of filing Form 20-F) contains relevant information as measured by analysts' revisions. Further, variables representing analyst following, change in reconciled earnings, and dispersion of analysts' expectations are significant in explaining the variation observed in positive abnormal revisions.     

Independent director cash compensation and earnings management

This study examines the impact of independent directors’ cash compensation on firms’ financial reporting quality using a sample of Chinese listed companies from 2002 to 2008. Unlike in the U.S. where most listed firms provide stock-related compensations to outside directors, Chinese listed companies compensate independent directors with cash only. This context offers a cleaner setting for examining the effects of independent director cash pay on earnings management. Our study documents a positive association between independent director cash compensation and the magnitude of earnings management. This suggests that compensating independent directors with higher cash pay compromises their independence and reduces their effectiveness in financial reporting oversight. Our results are robust to an array of sensitivity checks. These findings have important implications for both investors and policy makers by showing that independent directors’ cash compensation is also a significant determinant of financial reporting quality.     

The economics of earnings manipulation and managerial compensation

This article examines managerial compensation in an environment where managers may take a hidden action that affects the actual earnings of the firm. When realized, these earnings constitute hidden information that is privately observed by the manager, who may expend resources to generate an inflated earnings report. We characterize the optimal managerial compensation contract in this setting, and demonstrate that contracts contingent on reported earnings cannot provide managers with the incentive both to maximize profits and to report those profits honestly. As a result, some degree of earnings management must be tolerated as a necessary part of an efficient agreement.     

Employee sentiment and stock option compensation

The use of equity-based compensation for rank-and-file employees is a puzzle. We analyze whether the popularity of option compensation may be driven by employee optimism, and show that optimism by itself is insufficient to make option compensation optimal. The crucial insight is that firms compete with financial markets as suppliers of equity to employees and that employees’ access to the equity market restricts firms’ ability to profit from employee optimism. Firms must be able to extract some of the implied rents even though employees can purchase company equity in the financial markets. Such rent extraction becomes feasible if employees prefer the stock options offered by firms to the equity offered by the market, or if the traded equity is overvalued. We provide empirical evidence that firms use broad-based option compensation when boundedly rational employees are likely to be excessively optimistic about company stock, and when employees are likely to strictly prefer options over stock.