Discontinued operations and analyst forecast accuracy

Abstract

The Financial Accounting Standards Board requires separate reporting of discontinued operations within the income statement to provide better information about companies’ future earnings for financial statement users. However, discontinued operations can increase the complexity of forecasting earnings because a portion of permanent earnings is being eliminated, the future effect on continuing operations may be unclear, and there are incentives for opportunistic reporting. Additionally, anecdotal evidence also shows that analysts, an important proxy for financial statement users, have difficulty in adjusting their forecasts when companies report discontinued operations. This study empirically examines whether reporting of discontinued operations affects analyst earnings forecast accuracy. Our results suggest that forecast accuracy initially declines following the reporting of discontinued operations, and the effect is more pronounced for firms with lower quality discontinued operations disclosures. Results also show the initial decline in forecast accuracy dissipates after a year and is concentrated in firms with potentially more opportunistic reporting within discontinued operations.