Investor Reactions to Contrasts Between the Earnings Preannouncements of Peer Firms

Abstract

This study investigates how investors’ reactions to one firm’s earnings preannouncements are affected by the preannouncements of a peer firm. Our experimental results suggest that when two peer firms sequentially preannounce positive earnings news, investors’ assessments of the target firm’s one-year-ahead earnings per share (EPS) are affected by the peer firm’s preannouncing behaviors. We find that in such environments, preannouncing 50 percent of the positive news is not the best strategy for maximizing investors’ earnings predictions. Instead, we find that when differences exist in the two firms’ earnings preannouncements, contrast effects dominate investors’ predictions such that the greater the portion of the positive surprise preannounced by the target relative to the peer firm, the greater is the one-year-ahead EPS prediction for the target firm. However, when no differences exist between the surprises preannounced by the two firms, investors provide the highest one-year-ahead EPS forecast for the target firm when it follows the strategy of preannouncing 50 percent of the total earnings surprise. These findings suggest that investors’ reactions to earnings preannouncements are a complex function of the contrasts between the target’s preannouncements and those of its peers. Thus, they imply that the role of a target firm’s preannouncements on investors’ EPS predictions cannot be determined in isolation. Instead, the extent and nature of the preannouncements of peer firms must be considered in any such analyses. These findings have important implications for managers who make preannouncement decisions and academics examining market reactions to voluntary management disclosures.

Keywords: management earnings guidance, preannouncement, contrast effects

JEL Classification: M41