Meeting Company-Issued Guidance and Management Guidance Strategy

Abstract

We analyze the rationale for the market rewarding accurate management earnings guidance. We postulate that firms with better quality of information before investment also have better quality of information after investment but before earnings are realized. This late-interim information is of no value for production-investment decisions; however, by issuing accurate guidance, firms can signal a high-quality information environment, leading to better investment decisions in the future. We show that guidance accomplishment predicts future performance even if current earnings are not statistically correlated to future earnings. A manager interested in short-term market value tends to issue optimistic earnings guidance in equilibrium. Since the market rewards accurate guidance, though the management guidance is not verifiable, the equilibrium market valuation still induces the manager to issue informative guidance that enhances the investment efficiency through information quality discovery process.

Keywords: earnings guidance, information quality, investment efficiency

JEL Classification: M43, M41