On the Anomalous Stock Price Response to Management Earnings Forecasts

Abstract

This paper examines stock price formation subsequent to management forecasts of quarterly earnings. In the post-announcement period, we find a significant upward price drift for both good news forecasts and bad news forecasts. Combined with the asymmetry in the initial market response, the upward post-guidance drift in stock prices is consistent with a reversal of an initial overreaction to managers’ bad news forecasts and a continuation of an initial under-reaction to managers’ good news forecasts. This interpretation is supported by a negative (positive) relationship between the initial market response and the post-guidance drift in the bad news (good news) group. The drift pattern is robust to issues arising from measurement. Trading strategies exploiting the post-announcement drift suggest the existence of economically significant trading profits, net of estimated trading costs.