Analyst Information Precision and Small Earnings Surprises
46 Pages Posted: 28 Sep 2013 Last revised: 26 Jul 2017
This study proposes and tests an alternative to the extant earnings management explanation for zero and small positive earnings surprises (i.e., analyst forecast errors). We argue that analysts’ ability to strategically induce slight pessimism in earnings forecasts varies with the precision of their information. Accordingly, we predict that the probability that a firm reports a small positive instead of a small negative earnings surprise is negatively related to earnings forecast uncertainty and present evidence consistent with this prediction. Our findings have important implications for the earnings management interpretation of the asymmetry around zero in the frequency distribution of earnings surprises. We demonstrate how empirically controlling for earnings forecast uncertainty can materially change inferences in studies that employ the incidence of zero and small positive earnings surprises to categorize firms as “suspect” of managing earnings.
Keywords: Earnings surprise, analyst forecast error, forecast uncertainty, analyst incentives, earnings management, discontinuity, benchmark beating
JEL Classification: D80, M41, G24, G29
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