Negative Earnings Surprises Research Articles

Doing Organizational Identity: Earnings Surprises and the Performative Atypicality Premium

How do organizations reconcile the cross-pressures of conformity and differentiation? Existing research predominantly conceptualizes identity as something an organization has by virtue of the products or services it offers. Drawing on constructivist theories, we argue that organizational members’ interactions with external audiences also dynamically produce identity. We call the extent to which such interactions diverge from audience expectations performative atypicality. Applying a novel deep-learning method to conversational text in over 90,000 earnings calls, we find that performative atypicality leads to an evaluation premium by securities analysts, paradoxically resulting in a negative earnings surprise. Moreover, performances that correspond to those of celebrated innovators are received with higher enthusiasm. Our findings suggest that firms that conform to categorical expectations while being performatively atypical can navigate the conflicting demands of similarity and uniqueness, especially if they hew to popular notions of being different.

The Term Structure of Short Selling Costs

Abstract Short sellers care about (i) how overvalued an asset is and (ii) when the overvaluation will be corrected. Hence, short selling costs should be higher over horizons when negative information is more likely to arrive. This article presents a model formalizing this intuition and tests the model using the put–call parity condition. Forward shorting costs predict future costs and stock returns, consistent with an expectations hypothesis in the shorting market. Additionally, an upward sloping term structure around earnings announcements increases the probability of a negative earnings surprise, evidence that short selling costs are higher over horizons when negative information is more likely to arrive. My findings suggest that the term structure of short selling costs conveys how long overpricings are expected to persist.

Temporal evidence on threshold hierarchy based on accruals and real earnings management: Evidence from France and the US

Research Questions: Does the hierarchy of earnings thresholds differ between accounting systems? Does a temporal shift occur in the hierarchy of the earnings thresholds associated with earnings management? Motivation: A number of studies looked into the hierarchy of earnings thresholds based on the earnings distribution, capital market valuation, survey views, and discretionary accruals. Our study seeks to fill this gap by investigating the hierarchy of earnings thresholds based on real earnings management and by investigating if the hierarchy of earnings thresholds differs between accounting systems. Idea: This paper aims to examine the hierarchy of achieving certain earnings thresholds based on the magnitude of discretionary accruals and real earnings management under two different accounting models. Tools: Large samples of US and French firms for the period ranging from 2008 to 2018 are used. The relative extent of both discretionary accruals and real earnings management used to achieve three earnings thresholds is examined by regression analyses. Findings: Two hierarchies emerge from the US and French contexts. On the one hand, we find (1) avoiding earnings losses, (2) avoiding earnings decreases, and (3) avoiding negative earnings surprises in the US context. On the other hand, we find out (1) avoiding earnings losses, (2) avoiding negative earnings surprises, and (3) avoiding earnings decreases in the French context. An analysis of the real earnings management behavior of these firms indicates that they have used the significant real earnings management for the purpose of avoiding earnings decreases in both contexts. These hierarchies are reorganized over time. Contribution: Our paper contributes to the existing literature in several ways. First, the majorities of studies on earnings management examine and validate opportunistic incentives, whereas our results validate incentives with reference to the signaling theory. Second, our findings are of interest to investors, auditors, regulators and academics with respect to the financial statement analysis, accounting earnings quality, and financial reporting. Research limitations: This study is subject to measurement error which is a common limitation in the earnings management literature.

Executives’ Blaming external factors and market reactions: Evidence from earnings conference calls

We investigate how market participants react when corporate executives strategically blame the economy or industries for poor firm performance. In the quarters subsequent to earnings conference calls, we find that the “blame sentences,” which capture executives’ blaming tactics, predict negative and non-reverting abnormal returns, negative earnings surprises, and analyst recommendation downgrades. These blaming tactics also reduce the sensitivity of executives’ turnover to their performance. Our findings imply that executives strategically inject the negative information about future cash flows into blame sentences. Market participants need to combine distinct categories of information (firm-specific vs. economy-wide) to understand the implications of blame sentences, which consumes more cognitive resources and delays their reactions to the blame sentences.

COVID-19 profit warnings: Delivering bad news in a time of crisis

Profit warnings (large negative earnings surprises) are important corporate reporting documents for delivering bad news and a distinctive corporate communication genre. The 2020 COVID-19 exogenous shock provides a unique worldwide crisis context for company disclosure of bad news.The research develops a genre-based typology/analytical framework for assessing COVID-19 profit warnings’ quality comprising: (1) Four profit warning/forecast quality characteristics and (2) Eight profit warning/forecast disclosures. For a sample of 160 profit-warning documents, the research manually analyses their content, culminating in a disclosure quality score/index. The research tests a model of the factors influencing disclosure quality.The research finds companies regress to silence when investors most need guidance and poor-quality disclosure, coy ambiguous language, possibly reflecting minimal regulatory guidance on this form of corporate report. Two variables are significant – Profit warnings disclosed following Financial Reporting Council guidance are of higher quality and quality varies by industry. The paper finds faux disclosure and the performativity of disclosure, which may allow boards of directors to tick-box compliance with market abuse regulations. The paper concludes with recommendations for policymakers on improvements required to enhance the quality of these highly important corporate documents.

Option trading volume by moneyness, firm fundamentals, and expected stock returns

I examine the link between option and equity markets by considering the informational content of the option trading volume with respect to moneyness and maturity when the trade direction is unobserved. A high option trading volume of all maturity terms, deep-in-the-money put options, and deep-out-of-the-money call options, predicts higher leverage, increases in default risk, negative earnings surprises, and decreases in future profitability. In addition, option trading volume negatively predicts future stock returns. Information diffusion from the option market to equities plays an important role in accounting for return predictability in option trading volume. Such predictability is less evident in stocks with high institutional ownership and more analyst coverage.

Shorting Activity and Stock Return Predictability: Evidence From a Mandatory Disclosure Shock

We study the effect of a mandatory improvement in public disclosure due to the adoption of International Financial Reporting Standards (IFRS) on the stock return predictability of shorting activity. To assess the impact of the disclosure shock, we measure monthly changes in the demand for and supply of stocks for shorting and whether those changes predict negative returns in the following month. We provide international evidence that the ability of increases in shorting demand and supply to predict negative returns declines after the shock. The predictive ability of shorting in the month before a negative earnings surprise and news of a firm’s questionable M&A transaction also declines after the shock. These findings imply that the shock of the mandatory accounting change crowds out some of short-sellers’ value-relevant information in the equity lending market. Thus, while the democratization of information from a structured accounting change may make sophisticated investors worse off by reducing their ability to predict future returns, this change may also benefit all investors through timely stock price discovery.

Shorting activity and stock return predictability: Evidence from a mandatory disclosure shock

AbstractWe study the effect of a mandatory improvement in public disclosure due to the adoption of International Financial Reporting Standards (IFRS) on the stock return predictability of shorting activity. To assess the impact of the disclosure shock, we measure monthly changes in the demand for and supply of stocks for shorting and whether those changes predict negative returns in the following month. We provide international evidence that the ability of increases in shorting demand and supply to predict negative returns declines after the shock. The predictive ability of shorting in the month before a negative earnings surprise and news of a firm's questionable merger and acquisitions transaction also declines after the shock. These findings imply that the shock of the mandatory accounting change crowds out some of short‐sellers’ value‐relevant information in the equity lending market. Thus, although the democratization of information from a structured accounting change may make sophisticated investors worse off by reducing their ability to predict future returns, this change may also benefit all investors through timely stock price discovery.

Retail Investor Trade and the Pricing of Earnings

New technologies have reduced trading costs for retail investors. In this paper, I examine how the corresponding surge in retail investor trade is associated with the pricing of earnings. I measure retail investor trade with the number of Robinhood users holding a firm’s shares. I find increases in these relatively inexperienced investors are associated with a more positive market response to both positive and negative earnings surprises. This manifests in a more pronounced overall market response per unit of earnings surprise for positive earnings surprises but a muted market response for negative earnings surprises. Further intraday analysis suggests that retail investors respond to stock returns following the earnings announcement instead of the earnings news itself. Finally, in smaller firms and firms that are costly to sell short, and for both the most positive and negative earnings surprises, returns drift upward following the earnings announcement when retail trade is high.

Earnings Surprises and Stock Price Reactions of Quoted Companies in Nigeria

This study focuses on examining the relationship between stock prices and earnings surprises in quoted companies of Nigeria. This study applied a longitudinal research design which studies the effect of earnings surprises on stock prices using panel data. A sample of 64 companies was chosen to study in all sectors of the Nigerian Stock Exchange. The research data were obtained from secondary sources of the annual reports for the selected companies covering the period from 2013 to 2017. The measurement for earnings surprises used in the study is the residual or unexplained component of earnings persistence model commonly referred to as first-order autoregressive AR (1) regression of reported earnings. Were, the data analysis was carried out by regression using the generalised least squares technique. The regression results for positive earnings surprise shows that share prices react negatively to positive surprises with a coefficient of (-2.4109) in tandem with the return news hypothesis which suggests that positive earnings news results in a negative stock-price reaction. The negative earnings surprise results show that stock prices react positively to negative earnings surprises with a positive coefficient of (0.1136). This is in line with the premise of return news, which indicates that negative earnings news leads to a positive reaction to the share price. The study recommends that there is a need to regulate the stock market to improve the level of market efficiency in stock markets. This will improve the rate at which earnings news will be reserved at stock prices. Secondly, there is a need to improve investor confidence in the disclosed profits made by companies.

Anger, Fear, and Investor’s Information Search Behavior

This study investigates the differential effect of anger and fear on investors information search behavior. Based on theories from psychology, I predict that angry investors will seek out less additional information and exert a lower depth of thought than fearful investors after a negative earnings surprise. Additionally, I predict that these differences will be moderated in investors that exhibit higher levels of emotion management ability. Using an experiment, I find that neither anger nor fear had any effect on the number of additional information sources investors access. However, angry investors processed information less deeply than fearful investors. This is evident by significant differences in the amount of time spent reading additional information and the ability to recall details about the information. Finally, high emotion management ability reduces differences in depth of thought for both angry and fearful investors. The results of this study have implications for investors and researchers.

Rivals’ Negative Earnings Surprises, Language Signals, and Firms’ Competitive Actions

Research in competitive dynamics has primarily analyzed how characteristics of observable attacks influence firms’ competitive responses. Why and how firms take action in response to critical event...

Bearish Analysts and the Issuance of 'Unbeatable' Earnings Forecasts

We examine a sample of analysts who, despite having a bearish stock recommendation for a covered firm, issue an unusually optimistic earnings forecast at the end of the year. For the period 2004 through 2018, among analysts with an unfavorable stock recommendation, we find that about 5% issue a final earnings forecast prior to the earnings announcement that exceeds even the most optimistic earnings forecast issued by any other analyst covering the stock, presumably in an effort to increase the likelihood that the firm misses earnings expectations. More than 11% of all firm-year observations are subject to at least one such forecast at the hands of a bearish analyst. We find that analysts with pessimistic stock recommendations are more likely to issue these “difficult-to-beat” earnings forecasts when they have greater pressure to justify their negative view of the stock and when the earnings forecast has greater potential to revise investor beliefs. Nevertheless, stock returns associated with these optimistic forecast revisions are muted. We also find that although Thomson Reuters often excludes these forecasts from the consensus earnings estimate, the majority remain in the consensus and increase the likelihood that the firm misses the consensus forecast by about 21%. However, the market reaction to a negative earnings surprise is less severe when a bearish analyst has issued a difficult-to-beat forecast for the firm. Our study sheds light on one perverse strategy analysts use to increase the likelihood of an earnings miss.

Market fragmentation and post-earnings announcement drift

This paper examines the effects of dark and lit market fragmentation around both earnings announcements and earnings surprises. Results indicate that both dark and lit market fragmentation increase around earnings announcements. Further, I test whether dark and lit fragmentation hinder the level of price discovery around the earnings announcement, resulting in greater post-earnings announcement drift, PEAD. The analysis reveals that lit fragmentation has no significant impact on PEAD while dark fragmentation reduces the level of PEAD for stocks with positive earnings surprises. This result is consistent with the notion that dark venues capture more uninformed trading around positive news events, resulting in greater informed trading and higher informational efficiency in the lit venue. However, the results also indicate that dark fragmentation leads to stronger PEAD for stocks with negative earnings surprises. This last finding suggests that informed traders migrate to dark venues around negative earnings surprises, consistent with previous research that argues informed traders follow passive trading strategies around negative news events.

Number of Numbers: Does Quantitative Disclosure Reduce Uncertainty in Quarterly Earnings Conference Calls?

Theoretical research argues that numbers convey more precise information than words. Based on this work, we hypothesize that when managers provide disclosure with a greater proportion of quantitative information, information risk will decrease and firm value will increase. We offer three main findings. First, after controlling for the cash flow news in earnings conference calls, we find a positive association between the extent of hard information (i.e., numerical disclosure) and short-window stock returns around the call. This result suggests that information risk decreases when managers provide greater numerical disclosure. Second, we find that this positive association is larger when firms’ information environment is otherwise poor. Finally, we find that this positive association is larger when uncertainty about firm performance is higher (i.e., when the firm issues a negative earnings surprise). Overall, our results suggest that investors react to the extent of hard information (i.e., numerical disclosure) in earnings conference calls.

A Temporal Analysis of Expectation Management: Evidence from Public Management Earnings Forecasts

We investigate the time trend of expectation management through management earnings forecasts to avoid negative earnings surprise. We find that the percentage of firms missing analyst earnings target before downward management guidance but meeting revised analyst earnings target have more than tripled from 5.5% in 1995 to 20.0% in 2014. We also show increase of both the magnitude of pessimistic management forecast bias and analysts’ tendency to converge to management guidance, two potential explanations for increasing expectation management. Additional analysis indicates that the increase in analyst convergence is more prominent for firms with larger downward bias in previous management forecasts.

Strategic timing of corporate insiders when trading at earnings announcements

This paper provides new evidence that insiders exploit their stock’s mispricing after earnings announcements rather than their foreknowledge of future cash flows to make profitable trades. Insiders buy and sell more intensively shortly after the publication of earnings (from day 0 to +5) in response to market reaction to earnings announcement, and the explanatory power is higher relative to book-to-market and long-term past returns. Also, in line with insiders trading on mispricing, insiders’ purchases and sales are profitable both after positive and negative earnings surprises, which indicates that their trading strategies are superior to simple contrarian or momentum strategies.

The relationship insurance role of financial conglomerates: Evidence from earnings announcements

This paper uses earnings announcements to analyze the trading behavior and associated price impacts of institutions that have a lending or underwriting relationship with client firms and also hold client firms' shares. Buying support from relationship institutions mitigates the negative impact of earnings surprises on client firms' stock prices, predicts subsequent negative earnings surprises, and is also associated with less selling by independent institutions holding the same firms' shares. Price reactions for firms without relationship institutions are significantly larger. Price support from relationship institutions appears to help resolve uncertainty accompanying clients' temporary earnings shocks, thus reducing noise in the capital markets.

Preliminary Earnings Estimate and Dividends Payout Ratio: A Comparison Study on High-Tech vs. Low-Tech Industries

본 연구는 2012년부터 2017년까지 국내 상장기업들을 대상으로 첨단산업군 기업(이하 첨단기업)들과 비첨단산업군 기업(이하 일반기업)들을 구분하여 기업의 배당성향을 비교 분석하였다. 아울러 첨단기업들이 사전공시한 잠정이익과 회계감사 이후 확정되는 확정이익의 차이인 잠정이익공시오차에 따라 기업의 배당성향이 어떻게 다른지 실증 분석하였다. 분석결과, 일반기업들은 잠정이익을 확정이익보다 과대하게 공시하고, 첨단기업들은 오히려 축소하여 공시하는 경향이 있는 것으로 나타났다. 이는 첨단기업들이 잠정이익을 과대공시하여 확정이익이 잠정이익에 미달하는 경우, 부정적 어닝 서프라이즈(negative earnings surprise)에 상대적으로 더 큰 부담을 갖는다는 것을 시사한다. 첨단기업은 일반기업보다 투자에 대한 욕구가 강하고 외부자금 조달비용이 많이 들어서 될 수 있으면 현금배당을 줄여 초과현금을 사내에 보유하려는 경향이 있다는 사실도 확인할 수 있었다. 첨단기업의 잠정이익공시오차와 배당성향의 인과관계를 분석한 결과, 기업이 잠정이익을 과소하게 공시할수록 현금배당금이 감소하는 것으로 나타났다. 이는 새로운 투자수요가 상대적으로 큰 첨단기업들이 사전에 잠정이익을 보수적으로 공시하면서 주주들의 배당에 대한 기대심리를 낮추어 현금배당을 적게 하려는 의사결정으로 판단된다. 본 연구는 일반기업의 잠정이익 과대공시 경향에 대한 기존연구들의 관점에서 벗어나 첨단기업의 배당성향과 잠정이익 과소공시 수준의 인과관계를 규명하였다.This paper examines firms’ dividends payout ratios and preliminary earnings in high and low-technology industries. Furthermore, this paper studies how errors in preliminary earnings of high-tech companies, which is a difference between the finalized actual earnings and preliminary earnings estimate, affect their dividend payout ratios. From the study of Korean public companies between 2012 and 2017, it is revealed that high-tech firms tend to understate their preliminary earnings while low-tech firms tend to report higher preliminary earnings than their actual earnings. The implication is that, compared to low-tech corporations, high-tech firms are more vulnerable to negative earnings surprises due to overly optimistic preliminary earnings disclosure. Moreover, because high-tech firms are more likely to have greater investment opportunities and to incur increased external funding costs, they are thereby incentivized to maintain more cash within the company. They achieve this by decreasing their cash dividends to lower market expectations based on conservative preliminary earnings announcements. On the basis of empirical tests, this paper presents the amount of cash dividends decreases as firms understate their preliminary earnings.

Asymmetric Investor Reaction around Earnings Benchmark under Economic Uncertainty

AbstractThis study examines the effect of macro‐economic shocks on asymmetric investor reactions to earnings announcements. Specifically, we focus on a small range around the earnings benchmark and find a disproportionately large market penalty for firms with small negative earnings surprises (ESs) following an increase in macro‐uncertainty. By contrast, we find no evidence of an asymmetric market reaction to firms with small negative ESs following a decrease in macro‐uncertainty. While prior empirical research failed to document the large penalty for small negative ESs, our findings suggest macro‐economic shocks as a factor that explains the asymmetric pricing effect.