Actual Earnings Research Articles

The spillover effects of management overconfidence on analyst forecasts

Overconfident CEOs are known to overestimate their ability to generate returns, overpay for target firms, and take excessive risks. We find a CEO’s overconfidence can also indirectly affect other market participants, specifically analysts who issue earnings forecasts. First, firms with overconfident CEOs are more likely to have analysts issue earnings forecasts that are optimistic relative to actual earnings; that is, the earnings forecasts more frequently exceed the actual realized earnings than the reverse. Second, firms with overconfident CEOs tend to have less dispersed analyst earnings forecasts. And third, smaller analyst forecast errors are associated with firms that have overconfident CEOs. These findings demonstrate the importance of CEOs’ behavioral characteristics in shaping the environment in which analysts and other market participants make important financial decisions, in some cases improving the information environment.

Earnings Warnings and CEO Welfare

AbstractSome CEOs decide voluntarily to issue a warning when they expect a negative earnings surprise. Prior research suggests that warnings contain incremental information beyond actual earnings; warning firms tend to experience permanent earnings decreases. This paper investigates whether compensation committees take warnings into account in setting CEO compensation. We find that warnings are significantly negatively (positively) associated with CEO bonus (option grants), suggesting that compensation committees adjust CEO compensation towards a more high‐powered structure after warnings. However, the sensitivity of bonus or option grants to earnings and stock returns is not affected except for bonus sensitivity to stock returns. We also find weak evidence of an increase in forced CEO turnover after warnings, accompanied by a significant increase in its sensitivity to stock returns. This benefits CEOs with higher ability but imposes more risk on other CEOs. These findings provide a partial explanation of why not every CEO facing a negative surprise decides to issue a warning. Our results are robust to various specifications. In particular, the impact of warnings on compensation appears invariant to the timing or the number of warnings. Overall, these findings suggest that the signal from warnings is used in determining CEO compensation and retention.

Information in the Tails of the Distribution of Analysts’ Quarterly Earnings Forecasts

Investors generally measure earnings announcement news on the basis of the difference between actual earnings and two salient benchmarks: earnings in the same quarter the previous year and a consensus drawn from a distribution of forecasts by financial analysts. We evaluate the implications of a third salient benchmark: the most optimistic forecast when actual earnings exceed the consensus and the most pessimistic forecast when the consensus exceeds actual earnings. We find that considering the information in these tails of the distribution of analysts’ earnings forecasts enhances the profitability of post–earnings announcement drift strategies.

Has the Regulation of Non-GAAP Disclosures Influenced Managers’ Use of Aggressive Earnings Exclusions?

The frequency of non-GAAP (or “pro forma”) reporting has continued to increase in the United States over the last decade, despite preliminary evidence that regulatory intervention led to a decline in non-GAAP disclosures. In particular, the Sarbanes–Oxley Act of 2002 (SOX) and Regulation G (2003) impose strict requirements related to the reporting of non-GAAP numbers. More recently, the Securities and Exchange Commission (SEC) has renewed its emphasis on non-GAAP reporting and declared it a “fraud risk factor.” Given the SEC’s renewed emphasis on non-GAAP disclosures, we explore the extent to which regulation has curbed potentially misleading disclosures by investigating two measures of aggressive non-GAAP reporting. Consistent with the intent of Congress and the SEC, we find some evidence that managers report adjusted earnings metrics more cautiously in the post-SOX regulatory environment. Specifically, the results suggest that firms reporting non-GAAP earnings in the post-SOX period are less likely to (a) exclude recurring items incremental to those excluded by analysts and (b) use non-GAAP exclusions to meet strategic earnings targets on a non-GAAP basis that they miss based on Institutional Brokers’ Estimate System (I/B/E/S) actual earnings. However, we also find that some firms exclude specific recurring items aggressively. Overall, the results suggest that while regulation has generally reduced aggressive non-GAAP reporting, some firms continue to disclose non-GAAP earnings numbers that could be misleading in the post-SOX regulatory environment.

Who Herds? Who Doesn't? Estimates of Analysts’ Herding Propensity in Forecasting Earnings

AbstractWe develop parametric estimates of the imitation‐driven herding propensity of analysts and their earnings forecasts. By invoking rational expectations, we solve an explicit analyst optimization problem and estimate herding propensity using two measures: First, we estimate analysts’ posterior beliefs using actual earnings plus a realization drawn from a mean‐zero normal distribution. Second, we estimate herding propensity without seeding a random error, and allow for nonorthogonal information signals. In doing so, we avoid using the analyst's prior forecast as the proxy for his posterior beliefs, which is a traditional criticism in the literature. We find that more than 60 percent of analysts herd toward the prevailing consensus, and herding propensity is associated with various economic factors. We also validate our herding propensity measure by confirming its predictive power in explaining the cross‐sectional variation in analysts’ out‐of‐sample herding behavior and forecast accuracy. Finally, we find that forecasts adjusted for analysts’ herding propensity are less biased than the raw forecasts. This adjustment formula can help researchers and investors obtain better proxies for analysts’ unbiased earnings forecasts.

An exploratory study of determinants for restaurant servers’ actual tip earnings: Individual characteristics and work conditions

ABSTRACTThis exploratory study investigates two different types of determinants for servers’ actual tip earnings (individual characteristics versus work conditions) using readily available organizational data. Unlike previous studies that measured servers’ tips by asking subjects (servers or customers) to report tip amounts, we measure the actual tip earnings of each server extracted from the point of sale system. The results show that work conditions (daily work hours, weekend work hours, and immediate supervisors’ characteristics) have stronger relationships with servers’ tip earnings than servers’ individual characteristics (gender, tenure, and job satisfaction). This study represents an initial attempt to use objective data to measure servers’ tip earnings and explore its potential relationship with work conditions compared to its relationships with individual characteristics which have been frequently examined in previous studies.

Management earnings forecasts and IPO performance: evidence of a regime change

Companies undertaking initial public offerings (IPOs) in Greece were obliged to include next-year profit forecast in their prospectuses, until the regulation changed in 2001 to voluntary forecasting. Drawing evidence from IPOs issued in the period 1993–2015, this is the first study to investigate the effect of disclosure regime on management earnings forecasts and IPO long-term performance. The findings show mainly positive forecast errors (forecasts are lower than actual earnings) and higher long-term returns during the mandatory period, suggesting that the mandatory disclosure requirement causes issuers to systematically bias profit forecasts downwards as they opt for the safety of accounting conservatism. The mandatory disclosure requirement artificially improves IPO share performance. Overall, our results show that mandatory disclosure of earnings forecasts can impede capital market efficiency once it goes beyond historical financial information to involve compulsory projections of future performance.

The use of management forecasts to dampen analysts' expectations by Chinese listed firms

This paper studies the use of management earnings forecasts (MEF) to dampen analysts' expectations, i.e. expectation management, by Chinese listed companies. We reveal several important findings: Firstly, information asymmetry is positively associated with the use of MEF to dampen analysts' expectations. State control has been found to moderate this relationship. Secondly, dampening analysts' expectations using MEF leads to negative stock return reactions and downward analysts' forecast revisions. Thirdly, the effectiveness of “pre-empting bad news through MEF” appears mixed and dependent on the information content of MEF and measures of actual earnings surprises. Finally, firms that disclose MEF are found to engage in more earnings management to meet the forecasts than firms that do not.

Do Managers Provide Misleading Earnings Guidance Before Stock Repurchases?

We point out several methodological flaws in previous research that concludes that managers mislead shareholders into selling their stock for too cheap by releasing overly negative information before stock repurchases. In particular, this research relies primarily on measured market reaction to management guidance which suffers from endogeneity concerns. Using a sample of 3,181 repurchase firms and matching rival firms during 2003-2012, we find insignificant differences between their frequencies of management guidance, the implied earnings updates, and the closeness of earnings guidance to actual earnings. In contrast, there is a significant difference in market reaction to guidance, which is 1.5% lower for repurchase firms than for rival firms after accounting for differences in earnings updates and other information. Our evidence suggests that repurchases occur in response to investor misreaction to management guidance, but we find no evidence to suggest that managers mislead investors before this dominant form of shareholder returns.

"How Much is that Player in the Window? The One with the Early Birthday?" Relative Age Influences the Value of the Best Soccer Players, but Not the Best Businesspeople.

"How Much is that Player in the Window? The One with the Early Birthday?" Relative Age Influences the Value of the Best Soccer Players, but Not the Best Businesspeople.

Faktor yang mempengaruhi manajemen laba pada sektor perbankan Indonesia

Banks are responsible for the financial service in order that they become an important role in the community. They provide credit loan facilities for industries, government, small and medium business Banks can get into trouble if their performance in the fi-nancial report is not matching with the actual earnings. They have to present the fi-nancial report, so that the management gets a higher bonus and the stakeholders are satisfied and finally they can invest more money. The research tries to acknowledge the factors that influence the earning management. These factors are business risk, owner-ship structure (management structure and institution structure), banking size, and CAR. This research uses the data from 31 banks in Indonesia in the period of 2008 until 2012 and analyses them using a multiple linier regression test with dummy va-riables. It was found that the factors of management ownership, institution ownership, banking size, and CAR influence the earning management of banks in Indonesia.

Is There News in the Timing of Earnings Announcements?

This study examines the value relevance of the timing of earnings announcement dates relative to prior expectations. It shows that when firms advance their earnings announcements at least four days prior to expectations, the earnings surprises in those quarters tend to be positive and the abnormal returns from two days after the earnings release date was announced through one day after earnings are actually announced are positive and significant. The converse is true for firms that delay their earnings announcement at least four days relative to prior expectations. The study also shows that firms that delay their earnings release date at least four days after previously setting the date earlier are characterized by both negative earnings surprises and abnormal returns from the delay announcement through one day after the actual earnings announcement date. These results can be used by investors to earn abnormal returns, by security analysts in revising their forecasts and by option traders when earnings announcement dates cross option expiration dates. <b>TOPICS:</b>Fundamental equity analysis, portfolio theory, portfolio construction

Misclassifying Core Expenses as Special Items: Cost of Goods Sold or Selling, General, and Administrative Expenses?

Prior classification shifting studies pool core expenses together and conclude that managers misclassify core expenses as income-decreasing special items to inflate reported core earnings (e.g., McVay 2006; Fan et al. 2010). Their core expense measure combines cost of goods sold (COGS) with selling, general and administrative expenses (SGA). This study models COGS and SGA separately and investigates the choice of COGS versus SGA misclassification that managers make to meet different profitability benchmarks. We find that when reported gross margin shows a small increase from four quarters ago, COGS (but not SGA) misclassification is more prominent. In comparison, both COGS and SGA misclassification are more prevalent when firms report small core earnings or small increases in core earnings and when actual earnings just meet or beat the analyst forecast in the fourth quarter. Moreover, our study sheds light on real activities management (RAM) research. Specifically, we find that managers engage in RAM of COGS to achieve the gross margin benchmark, but not core earnings benchmarks. For SGA, we show that unexpected SGA contain a significant expense misclassification effect, suggesting the importance to control for expense misclassification effect for future RAM research. Overall, our study extends prior expense management literature on both classification shifting and RAM.

Opportunistic Use of Accrual Earnings in Financial Reporting: A Study of BSE Listed Firms in India

The study attempted to explore the role of discretionary accrual to conceal the actual earnings as a part of misapplication of flexible area in financial estimate in Indian BSE listed companies. As accruals have always provided a common opportunity to deceive financial statements users where the effect causes the financial statements not to be presented, in all material respects, and so along with the H&C (2002) model for total accruals, the most admired DeAngelo (1986) model has been applied for calculating discretionary accruals as part of the treatment for potential earnings management practices for the study. With the sample of BSE listed (industry wise) top 50 companies in India from 2010-2014, an attempt is made to investigate material misstatements issue with respect to industry classification on the basis of service and non-service sectors. It is found that the service sector industries are involve in income decreasing earnings management practices while non-service sector industries are in reverse practice. Apart from negative correlation between assets size of the firm and discretionary accruals. It is found that the entities of all sizes are susceptible with aberrant pattern and despite the fact that the large firms are engage in income decreasing earnings management practices, on the contrary the small firms are more likely involve in income increasing practices in financial reporting of service or non-service sector under which it is operating.

Key Factors Associated to Earnings Management of the Listed Companies on Tehran Stock Exchange (TSE)

Abstract. Due to the inherent flexibility in some of the accounting standards, interpretation and application of these practices is, in many cases, a function of managerial discretion and imposed views. Managers are provided with the opportunity which allows them through the use of diverse techniques, including accounting accruals, to manage the reported earnings. Earnings management is the manipulation of earnings aimed to secure achievement of management objectives through the use of safe methods and practices. A large body of the literature on earnings management consists of the studies primarily concerned with identification of certain relevant factors which are likely to have significant impact on earnings management. Present research highlights the key factors that contribute to earnings management in the listed companies on Tehran Stock Exchange. The research statistical population includes all listed companies on TSE with active trading record during 2007 through to 2012. Of this population, using systematic filtering procedure, 155 companies were selected as the research sample. The research hypotheses were tested at the hand of a particularly designed multivariate regression model aided by the fixed effects model and the ordinary least squares (OLS) technique. In this study, the effect of the independent variables difference between forecast and actual earnings per share on earnings management and prediction of the company’s future earnings growth on earnings management was examined. Earnings management was measured using modified-Jones model. The obtained results from test of the hypotheses did not indicate any significant association between difference between forecast and actual earnings per share and earnings management, while prediction of the company’s future earnings growth was found to be significantly associated with earnings management.

How does the market process sequential earnings information?

Employing both experimental market and archival research designs, we examine whether the association between announcement period stock returns and contemporaneous news is influenced by previously disclosed earnings news. Our primary conclusion is that investors' response to the earnings surprise (actual earnings less the last forecast of the quarter) is conditional on the sign of prior earnings news (i.e., the forecast revision). We develop and test predictions based on behavioral theories of how investors will react to a series of earnings information. Our results suggest that the market's response to sequential analysts' forecasts is consistent with the application of an end-of-sequence (EoS) process resulting in a primacy effect.

Why do analysts issue forecast revisions inconsistent with prior stock returns? Determinants and consequences

AbstractWe examine the informativeness of analyst forecast revisions that are directionally inconsistent with prior stock price movements (sign‐inconsistent revisions). Sign‐inconsistent revisions represent approximately one‐half of the forecast revisions from 1995 through 2010. Our tests indicate that sign‐inconsistent revisions are less informative than are sign‐consistent revisions. Sign‐inconsistent revisions are less likely to be closer to actual earnings realizations and they generate smaller stock price reactions. We also find evidence that sign‐inconsistent revisions are associated with analysts' economic incentives to generate trading volume and their behavioural limitations related to information uncertainty. These results suggest that sign‐inconsistent revisions do not necessarily benefit investors.

Firms’ earnings smoothing, corporate social responsibility, and valuation

Earnings smoothing via accounting discretion could improve or garble actual earnings information. Although managers prefer a less volatile earnings path and perceive lower risk for earnings smoothness, prior studies show that there is no discernible relation between smoothness and firm valuation. Recent literature documents that socially responsible firms behave differently from other firms in their earnings management and financial reporting. We conjecture that the reported earnings of smoothers that are socially responsible deviate less from their permanent earnings, thus their reported earnings are more value relevant. Our empirical tests show income-smoothing firms with higher corporate social responsibility (CSR) experience higher contemporaneous earnings-return relationship, greater Tobin’s Q, and stronger current return-future earnings relationship. The results show that CSR is proved desirable as it adds a unique “quality dimension” to earnings attributes and is useful for firm valuation.

Earnings Surprises in Analysts' Forecasts, Mandatory Disclosure, and Share Repurchases

This paper examines the impact of forecast errors and the mandatory disclosure of repurchase transactions required by 2003 Securities and Exchange Commission (SEC) regulations on share repurchases. We define forecast errors as the difference between analysts' forecasted earnings and actual earnings. We argue that firms with positive forecast errors imply greater information asymmetry, which may induce them to signal through share repurchases. We show that both the repurchase target and analysts' forecast revision are positively related to forecast errors. Furthermore, these associations are more pronounced in the low disclosure period (1989–2003) where greater information asymmetry between managers and outside investors is found, while increased transparency in the high disclosure period (2004–2006) leads to more significant improvement in long‐term performances for firms with positive forecast errors. The results are consistent with our expectations that the information asymmetry implied in forecast errors, along with a shock change from the introduction of the 2003 SEC regulation, affect both corporate and analysts' behaviour.

How do analysts interpret management range forecasts?

Range forecasts have evolved to be the most common form of management forecasts. Prior studies typically use the midpoint to evaluate analyst reaction to range forecasts, implicitly assuming that analysts place equal weights on the upper and the lower bounds of management range forecasts. We empirically test this restrictive assumption and provide strong evidence of unequal weights – analysts place significantly more (less) weight on the lower (upper) bound of forecast ranges. Moreover, such overweight on the lower bound is more pronounced when analysts face higher ambiguity, consistent with the “max–min” axiom, which predicts that decision-makers tend to assign higher probability to the worst-case scenario when facing ambiguity. Further tests show that “optimal revisions” with perfect foresight of actual earnings also overweight the lower bound.