Earnings Guidance, Bias, and Stock Price Crash Risk
Sophia J. W. Hamm
Ohio State University (OSU) - Fisher College of Business
Edward Xuejun Li
City University of New York (CUNY) - Stan Ross Department of Accountancy
Singapore Management University - School of Accountancy
April 13, 2016
Many recent studies have explored how the properties of mandatory disclosure, such as opacity, conservatism, and comparability, are related to future stock price crashes. However, Beyer et al. (2010) estimate that mandatory disclosures account for less than 12% of the total stock return variance explained by financial disclosures, compared to over 55% from earnings guidance. We extend prior studies by investigating the relation between earnings guidance, forecast bias, and crash risk. We find a significant positive relation between guidance and crash risk that is economically large. We show that optimistic guidance drives this positive relation. We also provide the first direct evidence on how the forecast bias gets impounded into price, which leads to future crashes. We conduct a battery of tests to mitigate concerns about endogeneity and alternative explanations. Overall, our findings highlight the agency problem in guidance disclosure and its effects on capital market beyond a short horizon.
Number of Pages in PDF File: 62
Keywords: crash risk, earnings guidance, forecast bias, agency problem
JEL Classification: G14, M41, M43
Date posted: May 9, 2012 ; Last revised: April 19, 2016
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