Does Meeting Expectations Matter? Evidence from Analyst Forecast Revisions and Share Prices
32 Pages Posted: 8 Nov 1999
Date Written: August 1999
This paper investigates whether firms achieve greater share value, all else equal, by meeting analysts' expectations. We hypothesize that such firms may be rewarded with higher earnings forecasts that lead to higher share values, or with higher share prices controlling for analysts' forecasts. We find that analysts' forecasts are not higher for firms that meet expectations relative to those that do not, controlling for the level of the current year's earnings information. We also find that one or two years ahead earnings are higher for firms that consistently meet expectations relative to those that do not, controlling for the level of analysts' post-announcement earnings forecasts, although earnings three years ahead are not generally greater for such firms. These findings indicate firms meeting expectations are not "rewarded" by analysts with higher earnings forecasts than are warranted. However, consistent with the hypothesis that the market rewards firms for meeting expectations, we find that share prices are higher for firms that consistently meet expectations than for those that do not. These tests control for an estimate of fundamental value based on the book value of equity and analysts' estimates of the present value of abnormal earnings. For firms meeting expectations in one year, the magnitude of the share price difference can be explained by the higher present value of future abnormal earnings realized by these firms. However, for firms meeting expectations in at least two consequent years, the market reward is greater and the incremental future abnormal earnings realized by these firms are of insufficient magnitude to explain the market reward. Our findings therefore support a market reward for firms that consistently meet expectations. This market reward could reflect a lower cost of capital for these firms or a distinct market premium for firms that meet expectations. In addition to documenting a market reward for meeting expectations, we contribute to the literature on financial analysts' processing of accounting information by developing a methodology to compare how analysts weight information with the ex post predictive ability of that information. This approach can be applied to a broad class of questions related to how analysts process information. We contribute to the literature on accounting-based valuation by developing a methodology for testing whether the value-relevance of a given factor derives from its implications for future abnormal earnings. We show that analysts' forecasts do not fully reflect available information, and that failure to adjust for this in valuation analyses can lead to misleading inferences.
JEL Classification: G12, G29, M41, M43
Suggested Citation: Suggested Citation