The Impact of Earnings Guidance Cessation on Information Asymmetry

Abstract

The practice of U.S. public companies issuing quarterly earnings guidance is coming under increased scrutiny and criticism. We test two competing hypotheses on whether information asymmetry will increase or decrease after quarterly earnings guidance cessation. The first hypothesis, “information transparency” hypothesis, states that information asymmetry increases after earnings guidance cessation because less information is provided to the market. The second hypothesis, “numbers game” hypothesis, states that information asymmetry decreases after earnings guidance cessation because managers no longer need to manage earnings to meet or beat their own targets and thus decrease information asymmetry. Using a large sample of firms during the years 2002-2011, we find that earnings guidance cessation significantly reduces information asymmetry for persistent guiders but not for occasional guiders. The information asymmetry reductions are positively related to the measure of earnings management before guidance cessation for persistent guiders. Thus our empirical results support the “numbers game” hypothesis. The study suggests that the reductions in information asymmetry are driven, at least in part, by firms engaging in less earnings management after guidance cessation.