Expectations Of Future Earnings Research Articles

Default risk and earnings expectations: The role of contract maturity in the credit default swap market

AbstractAgency conflicts increase with contract maturity. As contract maturity increases, managers, acting on behalf of shareholders, have more opportunities to use their discretion in ways that adversely affect future payoffs. Agency theory suggests that when contract maturity increases, creditors place less weight on a firm's growth opportunities in assessing default risk. We present a counter‐argument: because the timing of future payoffs is uncertain, longer‐duration debt provides creditors with a longer horizon over which payoffs are earned. Using credit default swap (CDS) spreads, we demonstrate that the relevance of future earnings expectations increases with CDS maturity. Our results suggest that contract maturity is not a reliable proxy for agency costs when evaluating the credit market relevance of financial information.

Deviation between willingness and actual behavior regarding community participation in protected areas: A case study in Shengjin lake national nature reserve in China

Introduction: The deviation between high willingness and poor actual behaviors in community participation has become an obstacle to achieving effective management and resource protection of protected areas. Therefore, it is necessary to investigate this deviation and its influencing factors.Methods: Based on a field survey of community residents in the Shengjin Lake National Nature Reserve (SJLNNR) in Anhui Province, China, this study uses a Logistic-ISM model to analyze the key factors influencing the deviation and the hierarchical structure supporting those key factors.Results: There is a significant deviation between participation willingness and actual behavior in SJLNNR. This deviation is characterized by eight key factors. Among these, awareness of the necessity of establishing SJLNNR is a direct factor at the surface level. Participation of important or recognizable people; average annual family income; understanding of environmental protection laws and regulations; realization of environmental improvement effect; satisfaction with SJLNNR authority; and future earnings expectations are all intermediate indirect factors. Furthermore, resident member is a fundamental factor. Resident members refer to those who live at home for six months or more during a calendar year.Discussion: These results indicate that there are three possible practical reasons for the deviation: 1) The lack of young and middle-aged adults is the root cause. 2) Inadequate ecological compensation is the direct trigger. 3) Individual internal psychological factors have significant effects. Furthermore, this study provides policy implications for converting willingness into actual participation in the community and promoting sustainable development.

Conservatism and stock price informativeness

AbstractThis paper examines how conservative financial reporting influences stock price informativeness, which is defined as the extent to which the current market price reflects future earnings information. Using the accuracy of the future earnings expectations embedded in the current equity price as a measure of stock price informativeness, I find that conservative reporting is positively associated with price informativeness. The results are robust to an alternative stock price informativeness measure, namely, specific return variation or price non‐synchronicity. Furthermore, I also find that a greater positive association between conservatism and stock price informativeness is associated with (1) lower analyst coverage and decreased forecast dispersion, (2) greater bid–ask spreads and greater R&D, and (3) lower financial disclosure quality, supporting the argument that main channel by which conservatism improves stock price informativeness is its impact on the information environment. Overall, the evidence suggests that (1) conservatism improves stock price informativeness by improving the firm's information environment, and (2) the marginal benefit of improvement in stock price informativeness via conservatism is more pronounced in firms with poorer information environments. The results further confirm that conservatism substitutes for information environments in ensuring more accurate equity pricing.

이익 변동성이 현재 주가의 미래 이익 기대에 대한 정보성에 미치는 영향

Purpose - This study investigates how earnings volatility influences current stock price informativeness about expectations of future earnings.
 Design/methodology/approach - I adopt the FERC model developed by Collins et al. (1994) and modified by Lundholm and Myers (2002) to investigate the connection between earnings volatility and future earnings reflected in current returns. I define five-year rolling standard deviations of earnings and components as earnings volatility measures and the degree of deviation of earnings from cash flows over the same five-year, which is developed by Jayaraman (2008).
 Finding - My results show that earnings volatility delays current stock price response to future operation expectations. They also verify that as earnings are more divergent from cash flows, current returns are less timely incorporating value-relevant future operation.
 Research implications or Originality This study shows that when volatile earnings deliver obscure and unreliable information about future operation expectations, they cause the market to be conflicting in understandings their implications and make it difficult in attaining correct future cashflow estimates.

기업의 ESG 활동과 주가동조성

In this study, the effect of the level of ESG activity of companies, which is receiving worldwide attention, on stock price informativeness, is to be confirmed through empirical analysis. Specifically, in this study, the effect of ESG activity on stock price informativeness was empirically analyzed through stock price synchronicity to determine how the ESG activity performance of an individual company had an effect on the volatility of market returns and industrial returns. If investors judge a company’s ESG activities and performance as useful accounting information for forecasting future prospects, they will make investment decisions with more weight on the company’s ESG information when forming future earnings expectations. In this case, the level of stock price movement will be low due to the high explanation of the company’s ESG information. On the other hand, ESG activities and performance will facilitate the use of future vision and information for investors, which will improve the flow of information to the market, and increase information efficiency, which will improve stock price information. The research sample was December settlement companies in the KOSPI market and KOSDAQ market from 2018 to 2021, targeting non-financial listed corporations, and ESG, the main independent variable, was subjected to empirical analysis targeting KOSPI 200 ESG constituents. As a result of empirical analysis, a company’s ESG activity showed a significant positive(＋) correlation with stock price movement. This shows that ESG-active companies have high information efficiency because the unique information of individual companies is sufficiently reflected in the stock price. In other words, it can be judged that companies that actively engage in ESG activities have a high level of information environment and that sufficient information is reflected in their stock prices. The implication of this study is that it will be helpful for creditors and investors to make investment decisions by considering ESG management activities and performance information of companies as ethical management and transparency based on the results of this study. And it is expected that it will be able to induce ESG management activities of companies.

Caught in an Expectations Trap: Risks of Giving Securities Analysts What They Expect

Although recent research shows that there is mounting pressure on firms to achieve earnings expectations of securities analysts, firms are far from being passive conformers; many firms proactively manage such pressure, particularly with earnings management tools. Yet why does the pressure to meet analyst expectations persist despite firms’ efforts to reduce it? To address the question, we develop an intertemporal model of the mutually reinforcing relationships between analyst expectations and firms’ strategic response, combining the behavioral theory of the firm and the concept of expectations trap. We argue that firms’ efforts to meet analyst expectations strengthen their salience as a predominant performance benchmark and, in doing so, ironically put them under greater pressure from analysts in three sequentially related steps—escalating future earnings expectations, imposing more severe penalties for failure to meet heightened expectations, and generating compensatory action for missed expectations. Our analysis, using data on more than 700 of the largest listed U.S. firms between 1986 and 2015, supports our arguments. Our study expands the scope of the behavioral theory of the firm, by demonstrating the increasing importance of performance feedback based on analyst expectations. Our study also contributes to the research on earnings pressure, by illuminating why the pressure persists despite firms’ efforts to reduce or evade it, and finally to the literature on strategic management of external expectations, by elaborating its unintended, long-term consequences. Supplemental Material: The e-companion is available at https://doi.org/10.1287/orsc.2021.1569 .

Sentiment, Loss Firms, and Investor Expectations of Future Earnings*

ABSTRACTThis study investigates the mispricing of market‐wide investor sentiment by exploring the relation between sentiment and investor expectations of future earnings. Prior research argues that sentiment‐driven mispricing should be most pronounced for hard‐to‐value firms, such as those reporting losses (Baker and Wurgler 2006). Using investor expectations of future earnings, we provide empirical results consistent with this behavioral finance theory. We predict and find that investors perceive losses to be more (less) persistent during periods of low (high) sentiment; that (in contrast) investors perceive profit persistence to be lower (higher) during periods of low (high) sentiment; and that the effects appear stronger for loss firms relative to profit firms. We also document predictable cross‐sectional variation within losses (with the mispricing mitigated for losses associated with activities expected to generate future benefits), R&D, growth, large negative special items, and severe financial distress. Overall, our results document a new and important channel—investor expectations of future earnings—to explain sentiment‐driven mispricing.

Investors' Misweighting of Firm‐Level Information and the Market's Expectations of Earnings

ABSTRACTPrior studies use fundamental earnings forecasts to proxy for the market's expectations of earnings because analyst forecasts are biased and are available for only a subset of firms. We find that as a proxy for market expectations, fundamental forecasts contain systematic measurement errors analogous to those in analysts' biased forecasts. Therefore, these forecasts are not representative of investors' beliefs. The systematic measurement errors from using fundamental forecasts to proxy for market expectations occur because investors misweight the information in many firm‐level variables when estimating future earnings, but fundamental forecasts are formed using the historically efficient weights on firm‐level variables. Thus, we develop an alternative ex ante proxy for the market's expectations of future earnings (“the implied market forecast”) using the historical (and inefficient) weights, as reflected in stock returns, that the market places on firm‐level variables. A trading strategy based on the implied market forecast error, which is measured as the difference between the implied market forecast and the fundamental forecast, generates excess returns of approximately 9 percent per year. These returns cannot be explained by investors' reliance on analysts' biased forecasts. Overall, our results reveal that market expectations differ from both fundamental forecasts and analysts' forecasts.

Sentiment, Loss Firms, and Investor Expectations of Future Earnings

This study investigates the mispricing of market-wide investor sentiment by exploring the relation between sentiment and investor expectations of future earnings. Prior research argues that sentiment-driven mispricing should be most pronounced for hard-to-value firms, such as those reporting losses (Baker and Wurgler 2006). Using investor expectations of future earnings, we provide empirical results consistent with this behavioral finance theory. We predict and find that investors perceive losses to be more (less) persistent during periods of low (high) sentiment; that (in contrast) investors perceive profit persistence to be lower (higher) during periods of low (high) sentiment; and that the effects appear stronger for loss firms relative to profit firms. We also document predictable cross-sectional variation within losses, with the mispricing mitigated for losses associated with activities expected to generate future benefits: R&D, growth, large negative special items, and severe financial distress. Overall, our results document a new and important channel—investor expectations of future earnings—to explain sentiment-driven mispricing.

Sticky dividends: A new explanation

This study proposes a generalized partial adjustment model of dividends in which managers set target dividends based on adaptively-formed earnings prospects. We show that firms adjust dividends to their target payouts much faster than previously documented. When managers form future earnings expectations based on a longer time-series of earnings, target dividends tend to become more stable. Thus, actual dividends tend to be more in line with the targets, driving up the speed of adjustment. Our model offers an insight that sticky dividends could be a consequence of managers’ attempts to match dividend payouts with the smooth targets.

The benefit of labor cost disclosure: evidence from analyst earnings forecast accuracy

PurposeThe purpose of this paper is to investigate whether sell-side equity analysts use labor cost information when forming expectations of future earnings. The availability of disaggregated earnings components will benefit financial statement users to the extent that the additional information released by a firm is useful to infer differential persistence of disaggregated earnings components.Design/methodology/approachThis paper employs ordinary least squares, logit, and two-stage Heckman (1979) regressions which test whether analysts incorporate labor cost information into their earnings forecasts after controlling for a managerial self-selection to disclose labor costs, and further test whether a firm’s decision to voluntarily disclose labor costs improves analyst forecast accuracy.FindingsThis research finds that analysts incorporate labor cost information into their earnings forecasts after controlling for other earnings components. More importantly, this research shows that voluntary disclosure of labor cost information is positively associated with analyst forecast accuracy. Additional tests show that the benefit of voluntary labor cost information is more pronounced for firms with high information uncertainty and for analysts with less firm-specific experience and analysts affiliated with small brokerage houses.Originality/valueThis paper contributes to the literatures on the effect of labor cost on investors’ behavior and on analyst-specific factors in explaining analyst ability to predict future earnings.

Future Earnings Expectations and Earnings Attributes

We study how earnings attributes affect investors expectations about future earnings reflected in market prices. We separate the current earnings contribution to the formation of future earnings expectations through a fictitious valuation incorporating expectations informed only by current values of earnings. Its pricing error measures the extent to which future earnings expectations are constructed on information other than realized earnings. We investigate the association between this pricing error and eleven earnings quality constructs commonly used in the empirical literature measuring earnings volatility and predictability, cash flow and accruals smoothness, earnings smoothness relative to cash flow, accruals quality, relative conservatism and frequency of reporting special items. For a large sample of US non-financial firms over the period 1971-2014, we find that, although significant in individual analyses, most of the quality constructs are not relevant to expectation formation. The exceptions are the earnings smoothness and (to a lesser extent) the frequency of reporting special items.

Price Response to Factor Index Decompositions

textabstractAbnormal price reaction around S&P 500 index changes has been considered as strong evidence that long term demand for stocks is downward sloping. This notion, however, has recently lost popularity due to the evidence that new additions are accompanied with a contemporaneous change in future earnings expectations. In this study we show that factor index rebalancing is a true information free event. The cumulative abnormal return from announcement to effective day is 1.07% for new additions and -0.91% for new deletions and around two-thirds of this effect is permanent. We find a direct relationship between the magnitude of abnormal returns and the abnormal volume coming from index funds. The documented effect results in a direct loss to index fund investors of 16.5 bps per annum.

The Consistency of Mandatory and Voluntary Management Earnings Forecasts and Implications for Analyst and Investor Information Processing

In this study we examine whether managers' voluntary forecasts of future earnings are consistent with the implicit forecasts of future earnings that underlie a specific mandatory accrual, the valuation allowance. This accrual relies heavily on managerial estimation and is also based, in part, on managers’ private, forward-looking information. Thus, it provides an ideal setting to investigate the interplay between voluntary and mandatory financial disclosures. By examining the consistency between the voluntary and mandatory forecasts, we are also able to provide insight into whether the predictable accrual-related bias in voluntary earnings forecasts carries over into the mandatory forecast embedded in the valuation allowance. We then investigate whether the biased voluntary earnings guidance helps analysts and investors more accurately interpret the information in valuation allowance changes about future earnings expectations. To increase the power of our tests we utilize a sample of loss firms, which frequently record valuation allowances to fully or partially offset deferred tax assets.We first document that more than 62 percent of our sample of loss firms report valuation allowance changes and management earnings guidance that convey the same basic information about future earnings (i.e., either both forecast profit or both forecast loss). Thus, these voluntary and mandatory forecasts are largely consistent with each other. We then provide evidence that managers provide overly pessimistic forecasts for observations whose valuation allowance changes signal bad news about future earnings, but overly optimistic forecasts for observations whose valuation allowance changes signal strong good news about future earnings. Finally, our results suggest that managers' biased earnings forecasts actually help analysts and investors more accurately interpret the information about future earnings in valuation allowance changes. Our findings provide new insights into actions managers can take to improve investor and analyst processing of financial statement-based tax information.

Do firms use early guidance to disclose the effect of conservatism on future earnings?

Purpose By deferring profits and anticipating losses, conservatism makes earnings increases more persistent and earnings declines more likely to revert. Therefore, the level of conservatism in current earnings has implications for future earnings expectations. Past research shows that outsiders can fail to understand these implications. This paper aims to investigate whether firms help outsiders by voluntarily disclosing their expectations about how conservatism will affect future earnings trends. Design/methodology/approach The authors examine the likelihood and content of “early” earnings guidance – i.e. guidance about future earnings that is released around or before the announcement of current earnings. The sample is made of 8,820 annual earnings announcements, 62 per cent of which are combined with early guidance. Findings The authors find that the more conservative current earnings, the higher: the likelihood that the firm releases early guidance; the likelihood that the firm predicts a positive change in earnings; and the difference between the forecasted earnings and current earnings. The authors also find such guidance to be relevant to analysts, who use it to update their forecasts. Practical implications By showing that firms use early guidance to disclose the effect of conservatism on future earnings, the study is interesting to users and preparers because it shows that analysts need and use such disclosure; and regulators because it alleviates concerns about the information consequences of conservatism. Originality/value The findings show that firms do not refrain from committing to positive early guidance to disclose the earnings effects of conservatism. This is interesting in light of the difficulty of predicting such effects, the manager incentives to keep expectations low and the cost of committing to positive guidance instead of less risky qualitative disclosure alternatives. In this way, the authors contribute to the literature on the interrelation between voluntary disclosure and conservatism in financial reports.

The predictive qualities of earnings volatility and earnings uncertainty

This study examines the differential predictive power of past earnings volatility for analyst forecast errors and future returns. Past earnings volatility jointly captures two correlated, but distinct, earnings properties: time-series earnings variation and uncertainty in future earnings. To distinguish between these two earnings properties, we develop a forward-looking measure of earnings uncertainty that has a minimal mechanical link to variation in prior-period earnings realizations and does not rely on analyst forecasts. Our results suggest that future earnings uncertainty, and not time variation in earnings, is associated with overly optimistic future earnings expectations of equity analysts and investors. We provide the first empirical evidence on the relevance of future earnings uncertainty to analysts and investors over 1-year horizons. In addition, we provide empirical evidence showing that forecast dispersion is a poor measure of earnings uncertainty.

Analyst Report Readability, Earnings Uncertainty and Stock Returns

This study investigates the association among readability of analyst reports, stock prices, and expectations of future earnings. Readability is one important feature of analyst reports that may affect value-relevant information. We find that analyst report readability reduces forecast dispersion but is not associated with revision news, and that market reactions are significantly positive towards more readable reports. In addition, we document that the market reacts positively to the reduction of forecast dispersion predicted by report readability. Finally, the positive effect of readability on stock prices is higher when it effectively reduces investors’ costs to process analyst report information, specifically when forecasting firms have more R&D spending, when transaction costs are higher, when analysts are more experienced, or when forecasts are issued after earnings announcements. Overall, our empirical findings suggest that the writing of analysts’ reports reduces uncertainty about future earnings, and investors price that reduction of uncertainty. This contributes to the understanding of the role of analysts as information intermediaries for investors.

Stock prices as a leading indicator of economic activity in South Africa: Evidence from the JSE

ABSTRACTMost asset pricing theories suggest that stock prices are forward looking and reflect market expectations of future earnings. By aggregating across companies, aggregate stock prices may then be used as leading indicators of future real GDP and real industrial production. A Hodrick and Prescott (1981) filter is used to detrend the data which is compiled on an annual and quarterly basis. An autoregressive model is constructed to test whether the cycle of real stock prices can be a useful indicator of the cycle of real economic activity. The results from this study using both quarterly and annual data show that in a South African context, the cycle of real stock prices on the JSE leads the cycle of real economic activity.

Through the Looking Glass: Are Sustainable Tax Strategies Reflected in Earnings Persistence?

This study examines whether the sustainability of a firm’s tax strategy provides information about the persistence of a firm’s pre-tax earnings and earnings components. We also investigate whether investors are able to determine the sustainability of a firm’s tax strategy and use it as a signal to correctly price the persistence of a firm’s pre-tax earnings and earnings components. Sustainability is an additional dimension of a firm’s tax strategy that focuses on maintaining consistent tax avoidance outcomes over time. Consistent with the sustainability of a firm’s tax strategy providing unique information about earnings persistence and reflecting managers’ expectations of future earnings, we find that firms with more sustainable tax strategies exhibit more persistent pre-tax earnings and earnings components. We also find that investors are able to infer the sustainability of a firm’s tax strategy and use it as a signal to assess the persistence of pre-tax earnings and earnings components.

Accruals, Disclosure and the Pricing of Future Earnings in the European Market

Abstract: This paper examines the role of disclosure in assisting market participants to form expectations of future earnings from the accrual content of reported earnings. Using the Transparency and Disclosure ratings prepared by Standard and Poor’s, we show how disclosure and accruals jointly affect the earnings expectations that are incorporated in current stock returns, depending on the magnitude and sign of the changes in net current and net non‐current operating assets.