The Effect of Beating and Missing Analysts' Forecasts on the Information Content of Unexpected Earnings

Abstract

This study investigates whether the market rewards (penalizes) firms for meeting (not meeting) analysts' earnings forecasts. Specifically, we examine the market response to positive and negative forecast errors. In addition, we examine whether the sensitivity of stock prices to positive or negative forecast errors is affected by the firms' history of consistently beating or missing analysts' forecasts. The results indicate that the earnings multiple applied to positive unexpected earnings is significantly greater than for negative unexpected earnings. In addition, we find that after controlling for the magnitude of the forecast error and bad news preannouncements, the market penalty for missing forecasts is significantly greater in absolute terms than the response to beating forecasts. We document evidence that, while the market recognizes and partially discounts the systematic component of positive analysts' forecast errors, a higher multiple is attached to the unsystematic component of unexpected earnings of firms that consistently beat analysts' forecasts. Overall, the evidence suggests that the increasing frequency of positive forecast errors as documented in previous research is a rational response by managers to market-related incentives.

Does Corporate Governance Matter in Meeting and Beating Analysts’ Forecasts

“…We also consider performance; earnings estimates are more accurate for performing and profitable firms (Lopez & Rees, 2002). We also control for long term growth (LTG), in fact, according to Matsumoto (2002), high growth firms have greater incentives to avoid negative surprises.…”

“…Many studies have interested on meeting analysts forecasts, some of them are focused on consistently meeting analysts' forecasts (Note 1) (Kasznick & McNichols, 2002;Lopez & Rees, 2002;Kross, Ro & Suk, 2011). Reviewing emerging research about consistently meeting or beating expectations: CMBE (Note 2), we have to make three observations: First, the majority of these studies focused on the effect of CMBE essentially on capital market i.e.…”

“…According to Kasznick and McNichols (2002), the market assigns a higher value to firms that meet expectations consistently; this premium is persistent and not reversed over three years. For Lopez and Rees (2002), the market recognizes historical patterns of surprises and adjusts for the systematic component of unexpected earnings; it rewards firms that consistently beat forecasts by attaching a higher multiple of the unsystematic portion of unexpected earnings. In general, firms characteristics studied are essentially earnings response coefficient and cost of capital, so few research were concerned by fundamental and characteristics of these firms.…”

Voluntary Disclosures and Information Production By Analysts

“…Indeed, recent studies suggest that managers care tremendously about meeting or exceeding analysts' expectations (Bartov et al, 2002;Lopez and Rees, 2002).…”

The Association of Real Earnings Management with: Enterprise Resource Planning Systems, Audit Effort, and Future Financial Performance

“…The literature suggests that managers are willing to engage in this behavior because the capital markets reward those firms that meet or beat earnings thresholds (Barth, Elliott and Finn 1999;Bartov, Givoly and Hayn 2002;Lopez and Rees 2002).…”