Future Earnings Research Articles

Beyond the street EPS surprise – when ‘other surprises’ matter in explaining earnings announcement returns

This study examines when accounting surprises other than the street EPS surprise, i.e. ‘other surprises’, are useful to investors. First, ‘other surprises’ are incrementally important when companies use earnings management to beat the analyst consensus EPS forecasts and when earnings quality is low. Second, ‘other surprises’ are useful in interpreting quarterly results for (i) growth stocks, (ii) stocks with high institutional ownership (particularly by active institutions and blockholders), and (iii) in interpreting the quality of the street EPS surprise. Third, the street EPS surprise shows no association with earnings announcement returns controlling for ‘other surprises.’ This result reflects that some ‘other surprises’, such as the net income surprise, are better predictors of future earnings surprises than the street EPS surprise.

Does industry co-location improve corporate information environment?

This study examines how the co-location of firms within the same industry enhances their information environments. We hypothesize that benefits arise from two effects: the industry peer effect, involving intra-industry information spillovers, and the geographic peer effect, related to shared local economic conditions with nearby non-industry peers. Our analysis evaluates how these effects, both separately and jointly, impact analysts’ forecast properties and stock price informativeness regarding future earnings. We find that the industry peer effect is negatively related to forecast dispersion and positively related to forecast accuracy, while the geographic peer effect shows no significant correlation. In addition, stock price informativeness about future earnings is positively associated with the industry peer effect but not with the geographic peer effect. We also find that greater proximity to industry or local peers enables analysts to incorporate more private (relative to public) information into their earnings forecasts, thereby enhancing the firm’s information environment. JEL CLASSIFICATION: M41, D80, G10

The rise of the walking dead: Zombie firms around the world

We build a comprehensive new dataset spanning listed and private nonfinancial zombie firms across Advanced Economies and Emerging Markets over the past two decades. Our findings reveal a global rise in the prevalence of these unproductive and unviable firms, particularly since the Global Financial Crisis and the Covid-19 pandemic. We show that private firms exhibit lower zombification rates due to their lower average survival rates. Our paper also offers a new perspective on zombie lending drivers: lenders may rationalize zombie lending based on overly optimistic expectations of a recovery in zombies’ future earnings. We then document that macroprudential policies targeting bank capital and loan restrictions can effectively mitigate the adverse effects of zombification. However, strengthening the banking sector alone may not suffice without robust insolvency frameworks prepared to manage firm restructuring and insolvency.

The Brand Premium

Abstract We highlight the limitations of using cumulative advertising expenses as an input measure of brand value. Using two output measures—Interbrand’s data and a novel text-based measure—we find that an equal-weighted portfolio of top brands yields an annual abnormal return of 3%. The excess returns are driven by companies that develop their brands internally. Intangible factors proposed in the literature have no explanatory power for the premium. Analysts underestimate the future earnings of top brands, leading to significant excess returns following earnings announcements. We find no abnormal returns associated with the input measure of brand value. (JEL G4, G12, G14, M41)

Dividend signalling and investor protection: An international comparison

This study examines whether dividend changes signal future earnings growth in non-US markets following the Ham et al. (2020) methodology and whether the strength of the earnings signal varies with the level of investor protection. Based on the notion that weak investor protection reduces the cost of cutting dividends and as such increases managers’ discretion to change dividends, we expect that the strength of the earnings signal in dividend increases becomes weaker as investor protection decreases. In a sample drawn from 38 different markets, our results indicate while dividends can signal future earnings in non-US markets, the strength of the signal is weaker than that in the US. In line with our predictions, we find that for firms in a strong investor protection environment, dividend changes are correlated more strongly with subsequent earning changes than is the case for firms in weak investor protection environments.

A note on using the workability index (WAI) to predict future earnings capacity losses in moderate to severe partial disability cases

Purpose Disability experts are often called upon to analyze the economic impact of an injury. Determining future economic loss in cases of disabilities is difficult, particularly when the disabilities are considered partial in nature, and the individuals have some capacity to mitigate their future income losses. This paper examines one possible approach for examining reduced future income capacity in cases of partial disabilities, the use of the Work Ability Index (WAI) and Work Ability Scale (WAS). Materials and Methods Empirical data from one-hundred six cases is analyzed using a censored tobit regression to determine the relationship between scores on the WAI/WAS and verified long-term income losses for individuals who suffered disabling events. Results The study found a high correlation between the scores obtained on both the WAI and WAS measures, and future economic loss. The results suggest that these scales may be very useful in analyzing reduced future income capacity in situations involving partial disabilities. Conclusions This study assists the rehabilitation and disability expert to better understand the implications of a moderate to severe disability on the future income capacity of an injured person. It also provides additional support for the validity of the WAI/WAS scales.

A Financial Analysis and Valuation of First Solar, Inc.

First Solar is an American company specializing in thin-film photovoltaic solar solutions using Cadmium Telluride (CdTe) technology. This technology offers environmental protection and sustainability advantages. The company maintains market competitiveness through continuous technological improvements, enhanced efficiency and durability, and expanded production capacity. First Solar holds significant market share in the United States and India, aided by government incentives like the U.S. Inflation Reduction Act and Indias Production-Linked Incentive Program. The company is expanding globally through acquisitions and long-term agreements, with plans to build new factories in both countries to boost production. Financially, First Solar performs well in liquidity, solvency, and profitability, ranking in the upper-middle tier among industry competitors. Its healthy short-term debt solvency is indicated by strong current and quick ratios, while its low debt ratio and high interest coverage ratio highlight robust long-term debt solvency. The companys gross and net profit margins are stable and expected to grow. First Solars earnings per share (EPS) and revenue growth rates surpass those of its peers, and its price-to-earnings (P/E) and earnings growth (PEG) ratios suggest lower relative future earnings growth, enhancing investment appeal. In summary, First Solar demonstrates strong market competitiveness and growth potential with its advanced technology, sustainable business model, and solid financial performance, positioning it as a leader in the solar energy industry.

Option trading and equity price efficiency

This paper presents evidence that the reduction in option tick size enhances equity price efficiency. To address the endogeneity issue, I employ an exogenous event, namely the Penny Pilot program. The findings indicate that option trading mitigates equity misvaluation, reduces price delay, accelerates the incorporation of future earnings into equity prices, and eliminates the well-known Post-Earnings Announcement Drift (PEAD). The pilot program significantly increases trading volume and reduces trading costs during the pilot period. Furthermore, the effect of options-to-stock volume on future stock returns is stronger in firms with high short-sale costs. This evidence is consistent with the hypothesis that informed trading boosts trading volume in the options market and integrates information from the options market into equity prices, thereby enhancing equity price efficiency.

Voluntary disclosures by activist investors: the role of activist expectations*

Activist investors in a firm often voluntarily release information about their governance intentions to the public. Voluntary disclosure theory suggests that an activist investor will disclose when she expects other investors to respond positively and support her in upcoming corporate control contests. We find that activists’ disclosures are accompanied by positive abnormal returns, reductions in bid-ask spreads, and increases in future earnings relative to similar targets without voluntary activist disclosures. Disclosures by activists who demand a board seat (the most common demand) have the highest announcement returns, and disclosers also win proxy contests and directorships more frequently than non-disclosers. These findings suggest that the activist’s beliefs about investor response in both pricing and voting are an important driver of her disclosure choice.

Uncovering interfirm links through textual topic similarity: A comomentum analysis in financial markets

Using an unsupervised topic modelling methodology, we construct a cross-firm similarity measure based on the various topics extracted from Management Discussion and Analysis texts. Our findings indicate that the returns of firms with similar textual topics predict the focal firms’ future stock returns. A long-short portfolio constructed on this basis yields an annualised alpha of 17.03%. Further analyses show that the return predictability is stronger for stocks subject to limited investor attention and limits to arbitrage. Additionally, our textual linkage measure can also predict future earnings surprises. Overall, mispricing due to sluggish information incorporation acts as a potential explanation for return predictability.

College Selectivity, Choice of Major, and Post-College Earnings

<p style="text-align:justify"><span style="font-family:Times New Roman,Times,serif"><span style="font-size:16px"><span dir="ltr" lang="EN-US"><span style="color:black">College choice and choice of major are the most important decisions for future earnings. It is still unclear, however, what makes a greater difference—college or major—or whether a choice of college matters more for some majors, but not the others. Using cross-classified models and College Scorecard data, I show that a discipline is more consequential for future earnings than a college. The effect of STEM is substantial but is less pronounced at institutions with higher overall median earnings. The effect of college selectivity on earnings is more pronounced for non-STEM disciplines. Institutional characteristics—such as tuition, shares of graduates receiving different forms of financial aid, institutional size and location, and type of college—correlate with earnings of graduates. Racial and gender composition of an educational program correlate with expected earnings of its graduates even after control for other institutional and disciplinary characteristics. Models presented here provide a better understanding of the effect of college and major choices on future earnings.</span></span></span></span></p>

Do Analysts and Investors Efficiently Respond to Managerial Linguistic Complexity during Conference Calls?

ABSTRACT This paper examines whether analysts and investors efficiently incorporate the informational signals from managerial linguistic complexity (e.g., Fog) into their forecasts and trading decisions. We predict that a manager’s Fog during a conference call provides a signal of their private information through their willingness to engage with analyst questions. We find that informative (obfuscatory) managerial Fog provides a positive (negative) signal of future earnings growth. We also find that analysts efficiently revise their forecasts to both positive and negative signals, whereas investors only correctly interpret obfuscation during the call; there is a delayed price reaction to informative Fog. However, when buy-side investors ask questions during a call, we find an efficient price reaction to informative Fog. Our findings highlight an important benefit of two-way interactive disclosures and underline the importance of active call participation for efficiently incorporating linguistic signals of managers’ private information. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: D82; G14; G20; M41.

The Valuation of Loss Firms: A Stock Market Perspective

The proportion of exchange‐listed firms with negative earnings has increased to over 40% in recent years. Previous research shows that the valuation of these loss firms is comparably difficult due to their uncertain future earnings path. Given these valuation issues, we argue that the stocks of loss firms should be particularly prone to mispricing such that simple firm value proxies might allow the prediction of subsequent stock returns. Supporting this hypothesis empirically, we find that book‐to‐market and revenue‐to‐price positively predict the cross‐section of loss firms’ stock returns. In particular, these value effects are significantly stronger compared to gain firms. Our further analyses support a behavioural mechanism for the empirical observations as the return predictability is disproportionately strong around earnings announcements and as analysts are too optimistic for loss firms with low values of book‐to‐market and revenue‐to‐price. Our analyses on short selling and option trading indicate that sophisticated investors are aware of the documented return predictability, but limits to arbitrage prevent an immediate correction of mispricing.

Policy uncertainty, bad news disclosure, and stock price crash risk

This paper documents that economic policy uncertainty reduces future stock price crash risk by increasing firms’ disclosure of bad news. Our tests show that firms release more bad news during periods of high policy uncertainty – they use more conservatism accounting, exhibit stronger future earnings response coefficients, use more negative tones in their financial reports, and have managers that express more negative sentiment in earnings conference calls than during periods of low policy uncertainty. Additional analyses show that the negative relation between EPU and future stock price crash risk is more pronounced among firms with more short-sale constraints, with no actively traded credit default swap contracts, with lower options-implied negative skewness, or with higher firm-level political risks. The results from regressions adopting the instrumental variable approach and from a quasi-natural experiment suggest that the negative relation observed between policy uncertainty and stock price crash risk is unlikely to be driven by potential endogeneity.

The Effect of Board Characteristics and Audit Report Delay on Future Earnings Management

The Effect of Board Characteristics and Audit Report Delay on Future Earnings Management

Stock exchange comment letters and MD&A tone management

This paper investigates the impact of stock exchange comment letters on MD&A tone management by Chinese listed firms. Our findings are twofold. First, abnormal positive MD&A tone is significantly reduced for firms receiving comment letters from stock exchanges. Second, comment letters have made abnormal positive MD&A tone more informative about future accounting earnings. Further analysis suggests that the treatment effect of stock exchange comment letters on MD&A tone management is more pronounced when the comment letters make stronger demands, or firms face greater concerns over proprietary information or attract more media attention. These findings are consistent with the view that stock exchange comment letters can restrain uninformative tone management leading to enhanced financial reporting quality.

Intangible and Tangible Investments and Future Earnings Volatility

This study delves into the impact of intangible and tangible investments on future earnings volatility within the European financial market context. Drawing from International Accounting Standards (IAS) 16 and 38, we examine the intricate relationship between fixed assets, expenses, and the uncertainty surrounding forthcoming earnings. Our analysis reveals that intangible assets, often associated with heightened uncertainty and risk, contribute to increased earnings volatility compared to capital expenditures. Furthermore, we find that capitalizing intangible assets serves to alleviate uncertainty, resulting in lower earnings volatility compared to expensing them. Our exploration of industries’ effects further reinforce these findings, with the effect of intangible and tangible investments on earnings volatility being more pronounced in high-tech industries than in low-tech industries. Additionally, our robustness test, utilizing goodwill as a proxy for intangible assets and property, plant, and equipment as a proxy for tangible assets, yields consistent results, further bolstering our findings.

Annual report tone and divergence of opinion: evidence from textual analysis

ABSTRACT By utilizing web-crawling and text analysis techniques on unstructured big data (text sets), this study examines to what extent investors disagree with the sentiment conveyed in annual reports. The main empirical findings suggest that the tone of annual reports significantly influences investor opinions. Specifically, a negative tone in annual reports is associated with high levels of divergence among investors’ opinions, whereas a positive tone correlates with lower divergence. In the robustness tests, the results remain consistent after controlling for various factors. After we control for Management Discussion and Analysis (MD&A), both positive and negative tones in annual reports continue to be significant predictors of divergences in investor opinions. Additionally, after controlling for future earnings quality, future cash flows, and future earnings surprises, investors still present high/low divergence of opinion in response to a negative/positive tone in annual reports. Moreover, the robustness of our analysis is assessed by employing alternative sentiment analysis word lists.

Does More Frequent Financial Reporting Bring the Future Forward?

SYNOPSIS Exploring mandatory financial reporting frequency changes in the United States from 1954 to 1972, we find that a mandatory increase in reporting frequency is associated with an increase in firms’ future earnings response coefficients. This effect is stronger for firms with higher sales seasonality or operating in industries with lower earnings persistence and for firms that provide more voluntary disclosures of forward-looking information after the reporting frequency increase. We also find that investors increase (decrease) the weight on long-term (near-term) earnings when pricing the firm after the reporting frequency increase. Our findings suggest that more frequent mandatory reporting can enhance the ability of investors to predict future earnings by providing additional useful information on future earnings and by triggering more voluntary disclosures. Our study informs the ongoing policy debates on mandatory financial reporting frequency by highlighting the informational benefit of frequent financial reporting for investors. Data Availability: Data are available from public sources identified in the paper. JEL Classifications: G14; M41; M48.

Sales Order Backlog and Credit Ratings

This study examines the association between sales order backlog and credit ratings. We posit that credit rating agencies consider order backlog as a positive signal about strong future demand and incorporate that into their rating decisions and provide higher ratings to firms with substantial order backlogs. However, being a non-GAAP, unaudited metric, order backlog could also reduce financial reporting quality and hence, credit ratings of firms. Using a sample of US firms from 1980 to 2017, we find a positive and significant association between order backlog and credit ratings, suggesting that order backlog serves as a valuable measure in credit rating assessment by providing positive signals about future earnings to rating agencies.