Management of Reported and Forecast EPS and the Extent to Which Investors Adjust

49 Pages Posted: 28 Aug 2016

See all articles by Foong Soon Cheong

Foong Soon Cheong

Nanyang Technological University (NTU) - Division of Accounting

Jacob K. Thomas

Yale School of Management

Date Written: June 30, 2016

Abstract

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

Suggested Citation

Cheong, Foong Soon and Thomas, Jacob Kandathil, Management of Reported and Forecast EPS and the Extent to Which Investors Adjust (June 30, 2016). Available at SSRN: https://ssrn.com/abstract=2830725 or http://dx.doi.org/10.2139/ssrn.2830725

Foong Soon Cheong (Contact Author)

Nanyang Technological University (NTU) - Division of Accounting ( email )

Nanyang Business School
Singapore, 639798
Singapore

Jacob Kandathil Thomas

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

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