Analyst information precision and small earnings surprises

Abstract

This study proposes and tests an alternative to the extant earnings management explanation for zero and small positive earnings surprises (i.e., analyst forecast errors). We argue that analysts' ability to strategically induce slight pessimism in earnings forecasts varies with the precision of their information. Accordingly, we predict that the probability that a firm reports a small positive instead of a small negative earnings surprise is negatively related to earnings forecast uncertainty, and we present evidence consistent with this prediction. Our findings have important implications for the earnings management interpretation of the asymmetry around zero in the frequency distribution of earnings surprises. We demonstrate how empirically controlling for earnings forecast uncertainty can materially change inferences in studies that employ the incidence of zero and small positive earnings surprises to categorize firms as suspected of managing earnings.

The Earnings Expectations Game and the Dispersion Anomaly

“…The low-dispersion firms clearly have a substantially stronger asymmetry in the earnings surprise distribution compared to high-dispersion firms. Consistent with Bissessur and Veenman [2016], low-dispersion firms are more likely to just beat quarterly earnings expectations and high-dispersion firms are more likely to just miss expectations. The striking di↵erence in the frequency distributions underscores the strong link between dispersion and firms' propensity to meet earnings expectations.…”

Earnings Expectations and the Dispersion Anomaly

“…Analyst incentives to pessimistically bias forecasts increase with earnings predictability. Bissessur and Veenman (2014) argue that analysts are better able to slightly low-ball their forecasts and help firms meet or just beat expectations when their information is more precise, and show that quarterly earnings forecasts are substantially more likely to exhibit a small pessimistic bias when analysts' face less earnings uncertainty. In addition, Hilary and Hsu (2013) show that analysts' understatement of forecasts relative to actual earnings is related to their forecast error consistency (i.e., the inverse of the variation in forecast errors).…”

“…acknowledged to more specifically capture uncertainty in short-horizon earnings expectations (e.g., Kinney, Burgstahler, and Martin, 2002;Sheng and Thevenot, 2012). Second, recent evidence links earnings uncertainty to the sign of ex-post bias in analysts' earnings forecasts (e.g., Jackson, 2005;McInnis, 2010;Bissessur and Veenman, 2014), which in turn affects the likelihood that a firm beats or misses consensus expectations at subsequent earnings announcements. Given the strong price reactions associated with firms' beating and missing analyst earnings expectations (e.g., Skinner and Sloan, 2002), the link between dispersion (i.e., earnings uncertainty) and analyst forecast bias can lead to predictable return patterns related to dispersion.…”

“…The link between dispersion and bias in analyst forecasts arises in part from analyst incentives to help firms meet or beat expectations by pessimistically biasing their forecasts before earnings announcements (Ke and Yu, 2006;Chan, Karceski, and Lakonishok, 2007;Hilary and Hsu, 2013;Malmendier and Shanthikumar, 2014). 3 Recent work by Bissessur and Veenman (2014) suggests that the likelihood of analyst forecast pessimism is inversely related to earnings uncertainty (measured by dispersion), and analyst forecasts tend to be optimistically biased when earnings uncertainty is high (e.g., Jackson, 2005;McInnis, 2010). Combined, analyst dispersion is associated with the sign of consensus forecast bias revealed at subsequent earnings announcements and hence the likelihood that a firm's earnings will beat or miss 3 Richardson, Teoh, and Wysocki (2004) show that the average analyst forecast is overly optimistic early in the year, but this optimism is reduced and switches to slight pessimism shortly before the annual or quarterly earnings announcement.…”

Recente inzichten in het gebruik van alternatieve prestatiemaatstaven door beursgenoteerde ondernemingen

“…de ondernemingen systematisch, ieder kwartaal, resultaten presenteert die minstens aan de verwachtingen voldoen. Alhoewel ondernemingen kostbare acties kunnen ondernemen zoals het sturen van de winst of het reduceren van discretionaire kosten, is een belangrijke rol in dit spel weggelegd voor de analisten, die prikkels hebben om managers te helpen aan de verwachtingen te voldoen door hun verwachtingen met een licht pessimistische bias naar buiten te brengen (Bissessur and Veenman 2016). Dit fenomeen wordt regelmatig behandeld in de financiële media (zie bijvoorbeeld Zweig 2011; Gryta et al 2016;Zweig 2018) en heeft ertoe geleid dat beleggers een kleine positieve earnings surprise vaak zien als rode vlag (Keung et al 2010).…”