Earnings Management and Guidance for Meeting or Beating Analysts' Earnings Forecasts

Abstract

We examine a comprehensive set of earnings management tools and forecast guidance to gain insights into the tools used by firms to meet or beat analysts' earnings forecast. Among the earnings management tools, in addition to discretionary accruals, we consider classification shifting (McVay 2006) and real activity manipulation: negative abnormal selling, general and administrative expenses (Gunny 2005), positive abnormal production and negative abnormal cash flow from operations (Roychowdhury 2005). We find that the use of downwards forecast guidance, upwards discretionary accruals and upwards classification shifting increases the probability of meeting or beating analysts' earnings forecasts by 9%, 5% and 10%, respectively; negative abnormal selling, general and administrative expense increases the probability of meeting or beating analysts' earnings forecasts by 3%; and positive abnormal production and negative abnormal cash flow from operations decrease the probability of meeting or beating analysts' earnings forecasts by 3% and 6%, respectively. We also find downwards forecast guidance, classification shifting and negative abnormal cash flows decreases the meet or beat premium by about 9% to 18%: investors appear to recognize the tools for achieving the benchmark and appropriately adjust the meet or beat premium.