The Consensus-Beating Game

53 Pages Posted: 21 Apr 2003 Last revised: 10 Jun 2011

See all articles by Tong Yao

Tong Yao

University of Iowa - Henry B. Tippie College of Business

Mark H. Liu

University of Kentucky - Gatton College of Business and Economics

Date Written: March 1, 2003

Abstract

This paper unveils the rationality behind the widely criticized practice of consensus-beating, where companies try to report quarterly earnings equal to or slightly exceeding analysts expectations. In a simple theoretical model we show that a high-growth company can use active earnings guidance and consensus-beating to credibly signal its growth potential to the financial market. We find empirical evidence in support of the model. Consensus-beating companies experience higher subsequent earnings. Earnings forecasts on those companies are less biased and more accurate. The market valuation is higher for consensus-beating stocks. All the above effects are most pronounced among stocks with high price-to-book ratio, a proxy for market perception of high growth potential. Finally, from 1985 to 2000, consensus-beating growth stocks significantly outperform value stocks and consensus-missing growth stocks in returns. The evidence runs contrary to the claim that stock market reacts to an uninformative event. Rather, it takes investors some time to sort out the information from a sophisticated game.

Keywords: corporate disclosure, earnings guidance, consensus-beating

JEL Classification: G14, G29, M41, M43, M45

Suggested Citation

Yao, Tong and Liu, Mark H., The Consensus-Beating Game (March 1, 2003). EFA 2003 Annual Conference Paper No. 399. Available at SSRN: https://ssrn.com/abstract=385600 or http://dx.doi.org/10.2139/ssrn.385600

Tong Yao (Contact Author)

University of Iowa - Henry B. Tippie College of Business ( email )

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Mark H. Liu

University of Kentucky - Gatton College of Business and Economics ( email )

550 South Limestone
Lexington, KY 40506
United States
859-257-9842 (Phone)
859-257-9688 (Fax)

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