Wealth Destruction Effects of Annual Management Forecasts
Posted: 10 Mar 2016 Last revised: 30 Aug 2017
Date Written: May 9, 2017
Annual management earnings guidance has grown significantly over the last decade, currently outnumbering quarterly guidance by a ratio of more than two to one. This trend coincides with the practitioner suggestion that annual guidance may potentially mitigate managerial myopia. In this paper, I exploit plausibly exogenous variations in annual guidance and find—in sharp contrast to practitioner suggestion—that the practice of providing numerical annual earnings forecasts exacerbates managerial short-termism. Specifically, I find that relative to firms that do not provide annual guidance, firms that do decrease selling, general and administrative expenses, R&D and capital expenditures significantly in an attempt to meet annual earnings target set by their own forecasts. The cross-sectional variations in myopic underinvestment predictably follow the cross-sectional patterns in annual guidance. I rule out several potential alternative explanations as the primary drivers of these results. In particular, falsification analyses mitigate concerns about an omitted factor explaining the results. Finally, the adverse real effects owing to increased annual guidance eventually manifest in value destruction.
Keywords: Management Forecasts, Management Guidance, Earnings Guidance, Inevitable Disclosure Doctrine, Myopia, Short-termism, Information Asymmetry
Suggested Citation: Suggested Citation