Beat Analyst Forecasts Research Articles

Earnings expectations and employee safety

We examine the relation between workplace safety and managers’ attempts to meet earnings expectations. Using establishment-level data on workplace safety from the Occupational Safety and Health Administration, we document significantly higher injury/illness rates in firms that meet or just beat analyst forecasts compared to firms that miss or comfortably beat analyst forecasts. The higher injury/illness rates in firms that meet or just beat analyst forecasts are associated with both increases in employee workloads and in abnormal reductions of discretionary expenses. The relation between benchmark beating and workplace safety is stronger when there is less union presence, when workers’ compensation premiums are less sensitive to injury claims, and among firms with less government business. Our findings highlight a specific consequence of managers’ attempts to meet earnings expectations through real activities management.

Meeting or Beating Management Forecasts: Implications for Managerial Talent

This study explores whether meeting or beating management forecasts is indicative of managerial talent. We find that the market reacts positively when firms meet or beat their management forecasts after controlling for meeting or beating analyst forecasts and management forecast errors. Further analyses reveal that firms meeting or beating management forecasts perform better in the future and are more likely to retain their CEOs. These findings suggest that meeting or beating management forecasts provides information on managerial talent, which is valued by investors. Next, we examine when management forecasts are distinct from analyst forecasts with respect to their indication of managerial talent. We find that the market premiums from meeting or beating management forecasts are positively associated with both firm-specific uncertainty and managers’ firm-specific information advantages, while the market premiums from meeting or beating analyst forecasts are positively associated with analysts’ macro-level information advantages.

Fair value accounting of financial assets and analyst forecasts

We examine how listed firms’ financial asset holdings affect analyst forecasts. Using China A-share firms over the period 2009–2011, we find that (1) listed firms sell available-for-sale securities (AFS) to meet or beat analyst forecasts, and (2) that when firms hold AFS, their analyst forecasts are more accurate, less biased and less dispersed. However, whether firms hold trading securities (TS) has no significant effect on either analyst forecast accuracy or forecast dispersion. Further examination indicates that listed firms use AFS to manipulate earnings, and that outside governance by the financial market and legal environment cannot moderate this opportunistic behaviour. Finally, our empirical results show that analysts can see through firms’ earnings management in selling AFS. Thus, our results suggest that standard setters should consider managers’ opportunistic behaviour in derecognising financial assets.

Impact of Auditor and Audit Committee Report Changes on Audit Quality and Costs: Evidence from the United Kingdom

While substantial revisions to auditor and audit committee reporting are being discussed internationally, including in the United States, the impact of these reforms on audit quality is unknown. We exploit the United Kingdom’s recent regulatory changes and find that the U.K.’s new reporting regime is associated with an improvement in audit quality as proxied by significant decreases in absolute abnormal accruals and the propensity to just meet or beat analyst forecasts. While we find that audit fees marginally increased after the reporting changes, the increase is not significantly different from the fee change documented in the prior year, suggesting a possible time trend of increasing fees unrelated to the new requirements. We also fail to document a significant change in audit delay. Taken together, this study finds that new auditor and audit committee reporting requirements are associated with a significant improvement in audit quality without detecting significant incremental costs.

Do financial expert directors affect the incidence of accruals management to meet or beat analyst forecasts?

Evidence that firms adjust accruals to meet or beat analyst forecasts is pervasive. However, the implications for earnings quality are not clear. Managers can use this practice to mislead investors or to signal future earnings growth. Assuming boards are concerned about providing higher quality financial information, they should discourage managers from adjusting earnings to beat the target if adjustment diminishes earnings quality. Consistent with this prediction, I find a significantly negative relation between the probability that a firm beats the target by adjusting accruals and the presence of independent audit committee financial expert for firms with poor future performance.

CEO Overconfidence and Earnings Management During Shifting Regulatory Regimes

AbstractThis study examines the relationship of CEO overconfidence with accrual‐based earnings management, real activities‐based earnings management, and targeting to meet or just beat analyst forecasts. Following, we measure “overconfidence” based on the CEO's tendency to hold in‐the‐money stock options, as rational expected utility maximizers should exercise early to avoid overexposure to company idiosyncratic risks. The results show that before the Sarbanes Oxley Act of 2002 (SOX), companies of overconfident CEOs were more likely than other CEOs to engage in managing earnings through accelerating the timing of cash flow from operations and achieving analyst forecast benchmarks. After SOX, we find that overconfident CEOs are more likely to have income‐increasing discretionary accruals. They remain more likely to engage in real activities management through abnormally high cash flows, and also have abnormally low discretionary expenses. These results are consistent with overconfident CEOs feeling less constrained by SOX, and suggest that this individual characteristic works against regulators’ attempts to constrain earnings management by corporate executives. In contrast, we find that the tendency of overconfident CEOs to manage to targets decreases after SOX, perhaps due to changes in investor behavior in the new regulatory environment.

Do managers define non-GAAP earnings to meet or beat analyst forecasts?

We provide evidence consistent with firm managers opportunistically defining non-GAAP earnings in order to meet or beat analyst expectations. This result is robust to controlling for other tools of benchmark beating (e.g., discretionary accruals, real earnings management, and expectation management). We also find that managers tend to exclude more expenses from non-GAAP earnings when it is costlier to use accrual earnings management due to balance sheet constraints, indicating that these tools are substitutes. Lastly, we find that investors discount positive earnings surprises when accompanied by exclusions from GAAP earnings, suggesting that the market partially understands the opportunistic nature of these exclusions. Our evidence is consistent with managers opportunistically defining non-GAAP earnings in a way that analysts fail to fully anticipate, resulting in an increased likelihood of exceeding analyst forecasts.

Summaries of Papers in This Issue

Summaries of Papers in This Issue

How Does Financial Expert Director Affect the Incidence of Accruals Management to Meet or Beat Analyst Forecasts?

How Does Financial Expert Director Affect the Incidence of Accruals Management to Meet or Beat Analyst Forecasts?

Do Managers Define Non-GAAP Earnings to Meet or Beat Analyst Forecasts?

Several empirical papers document that there is a disproportionate number of firms that just meet or beat analyst earnings forecasts. Three explanations have emerged to explain this phenomenon: accruals manipulation, expectations management, and real activities manipulation. In this paper, we propose an alternative explanation: managers are opportunistically using the discretion afforded them in defining non-GAAP earnings to exclude enough expenses to allow them to exceed analyst forecasts. Using two empirical proxies for non-GAAP earnings, we find results that indicate the probability of meeting or beating analyst forecasts increases when managers choose to exclude expenses from GAAP and report a higher non-GAAP earnings number. We also find evidence that the market discounts the positive earnings surprises for firms that meet or beat estimates while using income-increasing non-GAAP exclusions. Finally, we find that this practice of meeting analyst estimates using income-increasing non-GAAP exclusions increased rapidly before Regulation G, leveled off during a period of heightened regulatory attention, but has begun again to increase in recent years.

Financial Statement Fraud Detection: An Analysis of Statistical and Machine Learning Algorithms

SUMMARY This study compares the performance of six popular statistical and machine learning models in detecting financial statement fraud under different assumptions of misclassification costs and ratios of fraud firms to nonfraud firms. The results show, somewhat surprisingly, that logistic regression and support vector machines perform well relative to an artificial neural network, bagging, C4.5, and stacking. The results also reveal some diversity in predictors used across the classification algorithms. Out of 42 predictors examined, only six are consistently selected and used by different classification algorithms: auditor turnover, total discretionary accruals, Big 4 auditor, accounts receivable, meeting or beating analyst forecasts, and unexpected employee productivity. These findings extend financial statement fraud research and can be used by practitioners and regulators to improve fraud risk models. Data Availability: A list of fraud companies used in this study is available from the author upon request. All other data sources are described in the text.

Did the Waste Management Audit Failures Signal Lower Firm-Wide Audit Quality at Arthur Andersen? *

This study investigates Arthur Andersen’s audit quality in the decade before the collapse of Enron. Andersen’s involvement in the Waste Management audit failures — which relate to audits of the company’s 1992- 1996 financial statements — led the SEC to accuse Andersen of issuing false and misleading audit reports and resulted in a permanent injunction that prohibited Andersen from further violation of securities laws. We examine whether the Waste Management audit failures were symptomatic of widespread audit deficiencies at Andersen. Using three empirical measures of audit quality — discretionary accruals, clients’ propensity to meet or just beat analyst forecasts, and accounting misconduct identified by Accounting and Auditing Enforcement Releases (AAERs) — we find no overall evidence suggesting lower average audit quality at Andersen relative to the Big 4 during the period 1992-2001 for a sample of S&P 1500 firms. Focusing on high litigation risk firms, however, we find larger absolute and income-increasing accruals and a greater propensity to meet or just beat analyst forecasts for Andersen clients relative to the Big 4 clients in the period August 7, 2000 to December 31, 2001, after Andersen’s divorce from Andersen Consulting. These findings provide some evidence that, after the divorce, Andersen was not able to constrain aggressive accounting where it may have mattered most, that is, among its clients with the highest litigation risk.

The relation between earnings management and financial statement fraud

Abstract This paper provides new evidence on the characteristics of firms that commit financial statement fraud. We examine how previous earnings management impacts the likelihood that a firm will commit financial statement fraud and in doing so develop three new fraud predictors. Using a sample of 54 fraud and 54 non-fraud firms, we find that fraud firms are more likely to have managed earnings in prior years and that earnings management in prior years is associated with a higher likelihood that firms that meet or beat analyst forecasts or that inflate revenue are committing fraud. We further find that fraud firms are more likely to meet or beat analyst forecasts and inflate revenue than non-fraud firms are even when there is no evidence of prior earnings management. This paper contributes to the fraud detection literature and the earnings management literature, and can help practitioners and regulators develop better fraud detection models.

CFOs and CEOs: Who have the most influence on earnings management?

This study examines the association between chief financial officer (CFO) equity incentives and earnings management. Chief executive officer (CEO) equity incentives have been shown to be associated with accruals management and the likelihood of beating analyst forecasts (Bergstresser and Philippon, 2006; Cheng and Warfield, 2005). Because CFOs’ primary responsibility is financial reporting, CFO equity incentives should play a stronger role than those of the CEO in earnings management. We find that the magnitude of accruals and the likelihood of beating analyst forecasts are more sensitive to CFO equity incentives than to those of the CEO. Our evidence supports the Securities and Exchange Commission’s (SEC) new disclosure requirement on CFO compensation. & 2010 Elsevier B.V. All rights reserved.

Making Sense of Cents: An Examination of Firms That Marginally Miss or Beat Analyst Forecasts

ABSTRACTThis paper examines the performance consequences of cutting discretionary expenditures and managing accruals to exceed analyst forecasts. We show that firms that just beat analyst forecasts with low quality earnings exhibit a short‐term stock price benefit relative to firms that miss forecasts with high quality earnings. This trend, however, reverses over a 3‐year horizon. Additionally, firms reducing discretionary expenditures to beat forecasts have significantly greater equity issuances and insider selling in the following year, consistent with managers understanding the myopic nature of their actions. Our results confirm survey evidence suggesting managers engage in myopic behavior to beat benchmarks.

The association between corporate governance and earnings quality: Further evidence using the GOV-Score

Abstract This paper reexamines the relation between corporate governance and quality of earnings using a summary governance measure. Prior research has used many surrogates for corporate governance including size and composition of board of directors, existence and composition of audit committee, and extent of institutional ownership. However, the criticism of the extant research has been that corporate governance comprises many facets and is not uni-dimensional. In this study we fill this void by using the Gov-Score developed by Brown and Caylor [Brown, D., and Caylor, M.L., (2006). Corporate governance and firm valuation. Journal of Accounting and Public Policy 25, 409–434.] to measure corporate governance. In the post-Sarbanes–Oxley period, we find evidence of a significant inverse relationship, namely higher levels of corporate governance are associated with lower absolute discretionary accruals and higher quality of earnings. Furthermore, our results suggest that only firms in the highest category of corporate governance experience significantly improved quality of earnings. Finally, as a test of robustness, we document that corporate governance is negatively associated with small earnings surprises. This implies that firms with weak corporate governance are more likely to manage earnings in order to meet or beat analyst forecasts.

'Other Information' as an Explanatory Factor for the Market Reactions to Firms' Meeting or Beating Analyst Forecasts

Although the extant literature finds that analyst forecasts are one of the most critical thresholds for setting market's expectations, we find that the market reacts negatively to 41-percent of firms that meet or beat analyst forecasts and positively to 43-percent of firms that miss analyst forecasts. Kothari (2001) argues that seemingly counterintuitive market reactions, like these, are attributable to (1) the market reacting to information not captured in the accounting process; and, (2) the transitory nature of earnings. The extant literature provides ample evidence of the latter, suggesting that counterintuitive reactions are often attributable to the transitory components of earnings. We find evidence supporting this claim as well, but we find that the market also reacts to 'other information', and these reactions are incremental to the reactions attributable to transitory earnings. Further tests reveal that these reactions to 'other information' may be attributable to commonly identified factors in the literature, such as long-run growth, market risk, analysts' forecast precision, price decreases from the prior quarter and firm size, but we find evidence that these reactions are also attributable to information contained in analyst forecasts beyond these factors. Our findings suggest, however, that these counterintuitive market reactions are, in part, attributable to the market overestimating the persistence of 'other information'.

Do analysts and investors fully understand the persistence of the items excluded from Street earnings?

Previous research has found that the items that are included in GAAP earnings but excluded from Street earnings to allow the firm to meet or beat analyst earnings forecasts (“MBF exclusions”) are more persistent than the other excluded items. In this study, I find that the difference in the levels of persistence between MBF and non-MBF exclusions declined after the introduction of Regulation G, which requires public companies that disclose non-GAAP earnings to also present GAAP earnings and a reconciliation of the two. Analysts underestimate the persistence of non-MBF exclusions, but the degree of this underestimation is lower in the post-regulation period. In contrast, there is little evidence to indicate that analysts underestimate the persistence of MBF exclusions in either time period. I also find strong (weak) evidence that investors underestimate the persistence of Street exclusions in the pre- (post-) regulation period. These results suggest that Regulation G constrains the practice of excluding recurring expenses from Street earnings to meet or beat analyst forecasts and helps analysts and investors to understand the persistence of Street exclusions.

CFOs and CEOs: Who Have the Most Influence on Earnings Management?

This study examines the association between CFO equity incentives and earnings management. CEO equity incentives have been shown to be associated with accruals management and the likelihood of beating analyst forecasts (Bergstresser and Philippon, 2006; Cheng and Warfield, 2005). Because CFOs’ primary responsibility is financial reporting, CFO incentives should play a stronger role than those of the CEO. We find that the magnitude of accruals and the likelihood of beating analyst forecasts are more sensitive to CFO equity incentives than to those of the CEO. Our evidence supports the SEC’s new disclosure requirement on CFO compensation.

'Benchmark Beating' as Evidence of Earnings Management: Review of the Literature

Abstract: This paper synthesises a new strand of earnings management research that uses distribution of reported earnings to detect earnings management instead of using discretionary accruals (DACCR), the conventional proxy for earnings management. The theoretical foundation for benchmark beating approach is derived from the 'prospect theory' developed by Kahneman and Tversky (1979) which shows that losses are more displeasing than the equivalent gain when evaluated from a particular reference point. Three such reference points are identified in the 'benchmark beating' literature, namely (i) avoiding losses; (ii) reporting small increase in earnings; and (iii) meeting or just beating analyst forecasts. Review of the empirical literature shows that there is an unusual discontinuity around zero for earnings level, earnings change and analyst forecasts than expected. Managers use available flexibilities under GAPP like deferred tax expense, tax expense, stock repurchase, restructuring charge reversals etc. to manage earnings for the purpose of achieving earnings thresholds. Research shows that stock-based compensation packages offered to managers is an important motivation for managers to engage in meeting or beating earnings thresholds. However, corporate governance mechanism like shareholder protection constrains managerial ability to meet or beat benchmark. Limitations of 'benchmark beating' literature for standard-setters are identified and some future research directions are provided.