Investors’ reactions to retractions and corrections of management earnings forecasts

Abstract

Timely voluntary disclosure of information by companies sometimes results in erroneous disclosure that must be later retracted (i.e., withdrawn) and/or corrected (i.e., replaced with a corrected disclosure). Although such retractions and corrections appear to be relatively easy and costless ways to fix the erroneous disclosure, our results generally show that both actions have unexpected effects on investor judgment. The results of four experiments, which are consistent with affect theory from psychology, indicate when a company provides a retraction of a previous erroneous voluntary disclosure, investors’ judgments continue to reflect the implications of the initial erroneous information. That is, investors under-adjust. In contrast, when a company provides a correction (alone or with a prior retraction) with an opposite earnings implication, investors tend to over-adjust. Our results also show that if investors do not form a strong initial affective reaction to the initial erroneous forecast, they are less prone to over-adjustment when the correction is later received. Implications for regulators and standard setters are provided.