Does lowball guidance work? An analysis of firms that consistently beat their guidance by large margins

Abstract

Lowball guidance is the practice of firm managers issuing overly cautious guidance that is later exceeded by a large margin upon earnings announcement. In this study, we examine this practice at the episode level, where a firm engages in it over multiple consecutive quarters. Using a control sample of firms that exhibited episodes of meet or small beats, we draw inferences specific to lowball guidance episodes. We assess their prevalence in a broad sample of firms and provide evidence related to two explanations of lowball guidance episodes: firms' earnings uncertainty, and to a lesser extent, firms’ attempt to appease sell-side analysts and institutional investors. Stock return tests suggest that there are short-term capital market benefits to lowball guidance episodes, but the benefits dissipate eventually. Our results indicate that episodes of lowball guidance likely appeal to certain types of market participants in the short term, but they are not sustainable.