Under-Promise, Over-Deliver: Institutional Shareholder Monitoring and Guidance Games

Abstract

I hypothesize that managers exploit institutional investor distraction by issuing more pessimistic earnings guidance to reduce earnings expectations. I empirically test this conjecture and address endogeneity by exploiting plausibly exogenous variation in firm-level institutional investor distraction caused by attention-grabbing events in unrelated parts of institutional investors’ portfolios. I show that institutional investor distraction leads to managers publishing significantly more earnings forecasts with a negative forecast error, compared to the actual earnings published later. This finding is consistent with institutional investor distraction positively affecting managers’ propensity to engage in downward expectations management. The effect is mainly driven by distraction of transient investors and by distraction of a firm’s largest shareholders. It is stronger in quarters preceding net insider selling, and if the prior quarter’s guidance was already downward-biased.