The Effect Firm Reporting Quality Has on the Issuance and Properties of Disaggregated Earnings Forecasts

Abstract

We propose that analysts are more likely to disaggregate earnings-per-share (EPS) forecasts into revenue and expense estimates when quality of firm financial reporting is low. The disaggregation happens because, compared to EPS forecast accuracy, revenue forecast accuracy is less adversely affected by poor reporting quality. Consequently, when reporting quality is low, investors rely more on revenue than EPS estimates in their investment decisions. Empirical tests confirm that analysts are more likely to supplement earnings forecasts with revenue estimates when firm reporting quality is poor. Further, we show that accuracy of EPS estimates, but not of revenue forecasts, reduces as firm reporting quality deteriorates. Finally, we confirm that the price reaction to EPS forecast revisions is lower for firms with poor reporting quality. However, the price reaction to revenue forecast revisions is unaffected by reporting quality, consistent with higher value-relevance of revenue than earnings forecasts for firms with poor reporting quality.

Keywords: analyst EPS forecasts, revenue forecasts, accruals quality

JEL Classification: M41, N20