The Effect of Meeting Analyst Forecasts and Systematic Positive Forecast Errors on the Information Content of Unexpected Earnings

39 Pages Posted: 19 Feb 2001

See all articles by Thomas J. Lopez

Thomas J. Lopez

University of Alabama - Culverhouse School of Accountancy

Lynn L. Rees

Utah State University - Huntsman School of Business

Date Written: February 2001

Abstract

This paper focuses on two distinct, but related, issues with respect to managers' incentives to report earnings that meet or exceed analysts' expectations. First, we assess the differential stock price sensitivity to earnings that meet or exceed analysts' expectations compared to those that do not. Second, we examine whether the market implicitly revises analysts' earnings forecasts for firms that systematically report earnings that exceed forecasts. We find that the earnings response coefficient (ERC) is significantly higher for firms that meet analysts' forecasts. Additionally, we find that the market recognizes and adjusts the forecast error of firms that exhibit a systematic pattern of reporting positive or negative unexpected earnings. The market fully adjusts for the systematic component of the forecast error when it is negative; however, only a partial adjustment is made when the systematic component is positive. Overall, our evidence suggests that managers who try to report earnings that meet analysts' forecasts are responding to two market incentives. First, the market provides a premium to positive forecast errors and assigns a higher multiple to the level of positive unexpected earnings. Second, though the market recognizes systematic bias in analysts' forecasts, it does not fully adjust for systematically positive forecast errors. Our evidence provides, at a minimum, a partial explanation for managers' fixation on reporting positive unexpected earnings.

Note: The editor notes that the original submission date of this abstract was September 16, 1999.

JEL Classification: M41, G14, G29

Suggested Citation

Lopez, Thomas J. and Rees, Lynn L., The Effect of Meeting Analyst Forecasts and Systematic Positive Forecast Errors on the Information Content of Unexpected Earnings (February 2001). Available at SSRN: https://ssrn.com/abstract=181929 or http://dx.doi.org/10.2139/ssrn.181929

Thomas J. Lopez

University of Alabama - Culverhouse School of Accountancy ( email )

Culverhouse College of Business
Tuscaloosa, AL 35487-0223
United States
205-348-2907 (Phone)

Lynn L. Rees (Contact Author)

Utah State University - Huntsman School of Business ( email )

3500 Old Main Hill
Logan, UT 84322-3500
United States
435-797-2272 (Phone)

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