Peering Into the Distance: What Does Management Forecast News Convey About Future Earnings and Returns?
49 Pages Posted: 24 May 2018
Date Written: April 27, 2018
We investigate the implications of unbundled management forecast news for future earnings and returns. We find that positive (negative) management forecast news predicts higher (lower) earnings over the upcoming year, but this positive relation flips sign to negative over the following two years. We show similar dynamics in asset prices: returns initially drift in the same direction as the news in the management forecast, but begin to reverse six months after the forecast and this return reversal continues over the following twenty-four months. We conduct several analyses which suggest that return reversals occur because investors over-extrapolate the earnings implications of management forecasts. First, we find the reversals are concentrated around subsequent earnings announcements. Second, we find that positive (negative) management forecast news leads to overly optimistic (pessimistic) analyst earnings forecasts. Third, we find that management forecasts which are less persistent (e.g. forecasts by firms with higher earnings volatility and forecasts that convey negative news) are associated with larger return reversals. Fourth, we find that increasing the frequency of disclosure attenuates the return reversals. Further, placebo news events are not associated with future reversals of earnings or returns. Overall, our findings shed light on the news conveyed by management forecasts and suggest that market participants overreact to unbundled management forecasts.
Keywords: Market Efficiency, Voluntary Disclosure, Managerial Forecasts, Over-Extrapolation
JEL Classification: G12, G14, M41
Suggested Citation: Suggested Citation