Provide Earnings Forecasts Research Articles

Geographic Peer Effects in Management Earnings Forecasts*

ABSTRACTBecause of clear economic links among industry peers, prior work has focused on documenting industry peer effects in various settings. Yet, while links also exist among firms in the same geographic area, few studies document geographic peer effects. We fill this gap by examining whether there are geographic peer effects in management earnings forecasts. We find that the likelihood that a firm voluntarily provides an earnings forecast is sensitive to the extent to which other firms in the same geographic area provide earnings forecasts. This geographic peer effect in forecasting is stronger for firms with greater exposure to local institutional investors, and when firms do forecast, liquidity improves more when a larger fraction of their geographic peers forecast. Furthermore, we use instrumental variable techniques to help alleviate the concern that these geographic peer effects are driven by omitted local economic factors that can lead firms to make similar disclosure decisions. Overall, our findings suggest that geographic peer effects in disclosure choices arise in part due to firms responding to capital market incentives created by local investors. Our study, therefore, contributes to the literature by documenting a unique dimension of forecasting decisions.

The Effect of Conditional Management Earnings Forecast Mandates on Voluntary Disclosure and Analyst Forecast Properties

This study examines the effect of a conditional management earnings forecast mandate on voluntary disclosure and the properties of analyst forecasts in China, where firms are required to provide earnings forecasts when they expect to either make a loss, turn from loss into profit, or experience a large change in earnings. We find that firms’ propensity to issue voluntary management earnings forecasts is higher when they anticipate the disclosure of mandatory management earnings forecasts in the future. This relation is stronger for government‐controlled firms. We also find a significant improvement in the quality of analyst earnings forecasts (measured by forecast accuracy and dispersion) for firms that provide voluntary management earnings forecasts, while the disclosure of mandatory management earnings forecasts is negatively associated with analyst earnings forecast quality. We document that this differential effect on analyst earnings forecast quality is attributable to the higher quality of voluntary management earnings forecasts. Further analyses suggest that the positive effect of voluntary management earnings forecasts on analyst earnings forecast quality is larger for firms with a relatively weak existing information environment. Our findings suggest that the conditional mandatory disclosure of management earnings forecasts can incentivize managers to provide voluntary forecasts, and that these voluntary forecasts play a greater role than mandatory management forecasts in improving firms’ external information environment in the Chinese capital market.

The role of debt contracts in analyst earnings forecasts

Financial analysts evaluate a firm’s performance and provide earnings forecasts for future periods. Analysts have limited access to firm financial information, particularly following the enactment of Regulation Fair Disclosure (Reg FD) on October 23, 2000, which may result in information asymmetry between analysts and firm insiders. However, banks are exempt from the Reg FD, and they can still access private information to qualify borrowing firms for better terms on loans. Analysts may accordingly use loan contracts as a source of information to reduce information asymmetry and improve their earnings forecasts. We find that during the quarters wherein companies sign loan contracts, analysts provide more accurate earnings forecasts with lower forecast errors. More importantly, we find that analysts revise their earnings forecasts upward following the issuance of loans with low interest rates, while they revise them downward following the issuance of loans with high interest rates. Overall, these results are consistent with financial analysts using the information provided in debt contracts to better evaluate a firm’s performance and provide more precise earnings forecasts.

Voluntary Disclosures When There Is an Option to Delay Disclosure

ABSTRACTWhat incentives drive managers to disclose immediately when they have an option to delay disclosures? I examine this question in a two‐period setting in which public news that is positively correlated with firm value arrives periodically. I show that, when the manager's likelihood of receiving information is independent of the public news, an informed manager is more likely to disclose immediately when the public news is good. This happens even as the disclosure threshold itself increases in the public news. My model provides a potential explanation for why managers have a higher propensity to provide earnings forecasts when current earnings are high. I also show that, even when disclosures are credible, the average price reaction to a voluntary disclosure is (i) decreasing in the magnitude of the public news and (ii) lower when the manager is more myopic. These results have potential implications for studies that use stock returns to measure the news contained in management disclosures.

The spillover effects of a bright-line regulation: evidence from China

Purpose The purpose of this paper is to investigate the spillover effects of a bright-line disclosure regulation that required Chinese listed firms to provide earnings forecasts if they anticipated specified, large earnings changes. Design/methodology/approach The paper examines the discontinuity of the earnings change distribution of firms listed on the Shenzhen Stock Market between 2010 and 2014. The paper finds that firms no longer subject to the bright-line test still exhibited discontinuity in earnings change distribution. The discontinuity lasted for at least three years with magnitude comparable to that of the firms still subject to the bright-line test. In addition, newly listed firms that had never experienced the bright-line test showed similar tendency to avoid the same threshold. There is some evidence that these firms’ avoidance of the −50 per cent changes was partly because of market pressure. Research limitations/implications Research on bright-line tests has to date focused on their immediate and direct effects on firms currently subject to such tests. This study finds that a bright-line disclosure regulation’s influence is not limited to the firms directly governed by the regulation. It could lead to widespread and long lasting distortions in financial reporting behaviors of firms not currently subject to such tests. Practical implications The paper has implications for regulators who study the economic consequences of bright-line regulations in general and analysts of the Chinese capital market in particular. Originality/value This is the first empirical report that bright-line disclosure regulations affected the financial reporting behavior of firms that were not directly subject to the bright-line tests.

CEO career concerns and expectations management

Purpose The purpose of this paper is to examine the impact of career concerns on CEOs’ use of expectations management to meet or beat analysts’ quarterly earnings forecasts. The authors posit that early career-stage CEOs are less (more) likely to use expectations management than are late career-stage CEOs if the market views expectations management as an opportunistic strategy (efficient process) due to reputational capital concerns. Design/methodology/approach The authors obtain data for CEO career stages and CEO compensation from ExecuComp, analyst earnings forecasts from the detailed I/B/E/S database, financial statement data from quarterly Compustat and stock returns from the daily CRSP database over the period 1992–2013. Findings The results are consistent with the opportunistic hypothesis and early-stage CEOs seeking to build reputational capital by avoiding the perception of engaging in an inefficient managerial strategy. The authors find robust evidence that late career-stage CEOs are more likely to engage in expectations management than early career-stage CEOs. Furthermore, the authors show that late career-stage CEOs tend to employ expectations management to boost the value of their equity-based compensation. Research limitations/implications The findings have important implications because the authors document a different implication of the “horizon problem” related to CEOs’ opportunistic forecasting behavior and the manipulation of analysts’ forecasts for CEOs who are approaching retirement. Practical implications The results have practical implications for analysts who provide earnings forecasts for firms whose CEOs are in early or late career stages and for investors who use such analysts’ forecasts in firm valuation models. Originality/value The authors contribute to the literature on expectations management by documenting how reputational incentives of CEOs affect the likelihood that managers engage in expectations management. The authors show that an important managerial incentive to engage in expectations management is CEO career concerns. Furthermore, the authors show that CEOs who are in early stages of their careers choose not to engage in expectations management due to the market’s perceived degree of opportunism pertaining to this strategy.

The association between earnings forecast in IPOs prospectuses and earnings management: An empirical analysis

This paper examines the level of earnings management for large IPOs that provide earnings forecasts and those that do not provide forecasts in the IPO prospectus. Using a sample f 368 IPO firms listed on the London Stock Exchange between 1985 and 2012, we find that the level of earnings management is lower for IPOs that provided earnings forecasts, than for those which did not provide a forecast. This evidence is robust, controlling for endogeneity and sample selection. Further tests reveal that IPOs that provide forecasts outperform their counterparts in the long run, using various long term performance measures. Overall, our results suggest that earnings forecasts at the time of listing convey useful information to investors on the quality of the company listing in the market.

Geographic Peer Effects in Management Earnings Forecasts

We find that the likelihood that a firm voluntarily provides an earnings forecast is sensitive to the extent to which other firms in the same geographic area provide earnings forecasts. This geographic peer effect in forecasting is stronger for firms with greater exposure to local institutional investors, and when firms do forecast, liquidity improves more when a larger fraction of their geographic peers forecast. Further, we use instrumental variable techniques to help alleviate the concern that these geographic peer effects are driven by omitted local economic factors that can lead firms to make similar disclosure decisions. Overall, our findings suggest that geographic peer effects in disclosure choices arise in part due to firms responding to capital market incentives created by local investors.

The Spillover Effect of Bright-Line Tests: Evidence from China

China’s Shenzhen Stock Exchange used to require firms listed on its ChiNext Board and Main Board to forecast earnings when they expected a loss, a profit after a prior loss, or an earnings increase or decrease by at least 50%. Starting from fiscal year 2011, all firms on the ChiNext Board are required to provide earnings forecasts regardless of expected earnings, and hence are no longer subject to these bright-line tests. Firms on the Main Board, however, continue to follow the original mandate with bright-line tests. We find that after the removal of the bright-line tests, ChiNext firms’ earnings change distribution still shows a discontinuity at the -50% threshold, with unusually low (high) frequencies of earnings changes just below (above) -50%, consistent with ChiNext firms manipulating earning to avoid the -50% earnings change threshold. Moreover, the magnitude of the discontinuity is similar to that of Main firms. This finding suggests that bright-line tests have spillover effect on firms not currently subject to these tests.

Does director affiliation lead to analyst bias?

This study examines the ability of security analysts to provide objective earnings forecasts for firms with which the analyst’s brokerage firm has a director affiliation. The affiliation that we examine is where the brokerage firm has, on its board of directors, a director or an upper management individual from the firm which an analyst at the brokerage firm provides coverage. We find that affiliated analysts tend to provide earnings forecasts that are insignificantly different from unaffiliated analysts in terms of accuracy. However, we also find that forecasts provided by affiliated analysts tend to be significantly more pessimistic than those provided by their unaffiliated counterparts. This pessimistic bias in their earnings forecast will more easily allow the covered firm to beat earnings expectations when earnings are realized. We find that this bias surfaced after the Global Settlement decision, an enforcement agreement between large investment banks and the Securities and Exchange Commission (SEC) regarding issues surrounding conflicts of interest.

Forecast Bias and Analyst Independence

This paper examines the accuracy of equity analysts who provide earnings forecasts for European companies. We find strong evidence of institutional bias in analysts’ forecasts, specifically, when analysts move between sell-side employers and independent employers, they issue more accurate forecasts while they are employed by independent firms. Moreover, these differences persist when we hold constant the set of firms these mobile analysts research. We find statistically significant differences in the forecast accuracy of sell-side and independent analysts. The optimistic bias of sell-side analysts appears to be related to underwriting activity. Analysts employed by lead underwriters produce less accurate forecasts for newly public companies than do either buy-side or independent analysts. The optimistic bias persists for a five-year period following an IPO.

Earnings Non‐Synchronicity and Voluntary Disclosure

Earnings non‐synchronicity reflects the extent to which firm‐specific factors determine a firm's earnings. Prior research suggests that high earnings non‐synchronicity impedes corporate outsiders' ability to process information. This study examines the impact of earnings non‐synchronicity on managers' decisions to provide earnings forecasts. We propose that high earnings non‐synchronicity motivates managers to issue earnings forecasts to reduce information asymmetry between managers and investors and to preempt costly information acquisition by outsiders. Consistently, we find a positive relation between earnings non‐synchronicity and managers' propensity to issue earnings forecasts, particularly long‐horizon forecasts. This positive relation is weaker when earnings are easier to predict based on the firm's earnings history and is stronger when the firm has higher institutional ownership and greater analyst following. We also find that the market's reaction to management forecasts increases with earnings non‐synchronicity. Overall, the evidence suggests that managers voluntarily provide earnings forecasts to alleviate the adverse consequences of earnings non‐synchronicity. These findings provide a more complete picture about the impact of earnings non‐synchronicity on a firm's information environment, and highlight the effect of the nature of information asymmetry on voluntary disclosures.

The Influence of Corporate Governance on Management Earnings Forecast Behaviour in a Low Private Litigation Environment

We examine the influence of three external corporate governance mechanisms - continuous disclosure regulatory reform, analyst following and ownership concentration and one internal corporate governance mechanism - board structure, on the likelihood, frequency, horizon, precision and accuracy of management earnings forecasts in the low private litigation environment of New Zealand. Based on a sample of 1,082 management earnings forecasts issued by 125 firms listed on the New Zealand Exchange during the 1998-2007 financial reporting periods, we provide strong evidence that these four corporate governance mechanisms have a significant influence on management earnings forecast behaviour after effectively controlling for endogeneity, multicollinearity and self-election bias problems. Specifically, firms monitored by effective corporate governance mechanisms were more inclined to pre-empt their earnings announcements with earnings forecasts (overall, non-routine and quantitative) and provide these earnings forecasts more frequently. These earnings forecasts issued by these firms were less optimistically biased. In addition, firms having more directors with accounting expertise on their boards and audit committees were more likely to provide earnings forecasts with longer horizon and smaller forecast error. Board size and the existence of a formally established audit committee are shown to have a positive impact on forecast error. A possible interpretation of our findings is that effective corporate governance mechanisms have been able to substitute for private enforcement alternative. Our findings should have important implications for the other low private litigation environments as well as for high private litigation environments such as the United States given the high economic and social costs that have been identified as being related to private litigation.

Earnings Non-Synchronicity and Voluntary Disclosure

Earnings non-synchronicity reflects the extent to which firm-specific factors determine a firm’s earnings. Prior research suggests that high earnings non-synchronicity impedes corporate outsiders’ ability to process information. This study examines the impact of earnings non-synchronicity on managers’ decisions to provide earnings forecasts. We propose that high earnings non-synchronicity motivates managers to issue earnings forecasts to reduce information asymmetry between managers and investors and to preempt costly information acquisition by outsiders. Consistently, we find a positive relation between earnings non-synchronicity and managers’ propensity to issue earnings forecasts, particularly long-horizon forecasts. This positive relation is weaker when earnings are easier to predict based on the firm's earnings history and is stronger when the firm has higher institutional ownership and greater analyst following. We also find that the market’s reaction to management forecasts increases with earnings non-synchronicity. Overall, the evidence suggests that managers voluntarily provide earnings forecasts to alleviate the adverse consequences of earnings non-synchronicity. These findings provide a more complete picture about the impact of earnings non-synchronicity on a firm’s information environment, and highlight the effect of the nature of information asymmetry on voluntary disclosures.

Lockup and Voluntary Earnings Forecast Disclosure in IPOs

We examine the relation between lockup length and voluntary earnings forecast disclosures for IPOs in Singapore. Unlike firms in the United States, companies in Singapore are allowed to provide earnings forecasts in their IPO prospectuses. We find that forecasters are more likely to accept longer lockup periods, so that the lockup expires after the first post‐IPO earnings announcement. Our study also shows that because the lockup agreement removes personal incentives to issue aggressive forecasts, IPO firms tend to issue conservative forecasts. Overall, our results suggest that the lockup mechanism adds credibility to the earnings forecast given in the IPO prospectus.

Evidence on the motivation for management forecasts of corporate earnings

AbstractA multivariate model of the process by which managers decide to release public forecasts of their firms' earnings is developed, based on factors that are hypothesized to affect the demand for and the willingness to supply such forecasts. We test the model on data from a comprehensive sample of earnings forecasts, and find support for our hypotheses about the likely joint influence of those factors. Larger firm size, greater leverage, higher and more stable earnings rates and less rapid growth rates are found to be associated with an increased propensity for management to provide earnings forecasts for their firms.