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Management of Reported and Forecast EPS, Investor Responses, and Research Implications

Management Science, Forthcoming

52 Pages Posted: 25 Jul 2017  

Foong Soon Cheong

New York University (NYU) - NYU Shanghai

Jacob K. Thomas

Yale School of Management

Date Written: March 27, 2017

Abstract

We document substantial management of reported and forecast EPS for analyst-followed US firms, with the extent of management increasing with share price. 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 differentially guide forecasts to improve accuracy. Whereas unmanaged forecast errors are much larger for high price firms, they are compressed to the point their magnitudes resemble those for low price firms. Managers also guide analyst forecasts to generate patterns of forecast walkdowns that again vary with share price. Given the remarkable level of management implied by our results, we conduct additional robustness analyses. The strongest evidence is observed in stock price responses: investors recognize efforts to manage reported and forecast EPS and adjust accordingly. We highlight potential biases caused by researchers being unaware of managerial efforts and investor responses, and offer ways to mitigate those biases.

Keywords: EPS Forecast Errors, Earnings Management, Forecast Guidance, Scale Deflation, and Earnings Response Coefficients

JEL Classification: G14, G34, M41

Suggested Citation

Cheong, Foong Soon and Thomas, Jacob K., Management of Reported and Forecast EPS, Investor Responses, and Research Implications (March 27, 2017). Management Science, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3007205

Foong Soon Cheong

New York University (NYU) - NYU Shanghai ( email )

1555 Century Ave
Shanghai, 200122
China

Jacob Kandathil Thomas (Contact Author)

Yale School of Management ( email )

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

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