Management of Reported and Forecast EPS and the Extent to Which Investors Adjust
49 Pages Posted: 28 Aug 2016
Date Written: June 30, 2016
We document substantial management of reported and forecast EPS for analyst-followed firms, with the level of management increasing with share price. Mainly, managers smooth the volatility of reported EPS by using accruals to offset cash flow shocks. Smoother EPS is easier to forecast, resulting in smaller forecast errors. Managers also reduce forecast errors by guiding analysts to increase forecast accuracy. Whereas unmanaged forecast errors are much larger for high price firms, they are compressed to the point they resemble errors for low price firms. Given the remarkable level of management implied by our results, especially for high price firms, we conduct additional robustness analyses and falsification tests. The strongest evidence is observed in investor responses per cent of forecast error: they increase proportionately with share price to compensate for differential compression. We show how this management and associated investor responses potentially bias research studies, and offer ways to offset such bias.
Keywords: EPS forecast errors; earnings management; forecast guidance; scale deflation; and earnings response coefficients
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