Expectations-Based Management

18 Pages Posted: 9 Nov 2006

See all articles by Tom Copeland

Tom Copeland

Massachusetts Institute of Technology (MIT) - Sloan School of Management; CRA International

Aaron D. Dolgoff

Charles River Associates


The authors begin by summarizing the results of their recently published study of the relation between stock returns and changes in several annual performance measures, including not only growth in earnings and EVA, but changes during the year in analysts' expectations about future earnings over three different periods: (1) the current year; (2) the following year; and (3) the three-year period thereafter. The last of these measures - changes in analysts' expectations about three- to five-year earnings - had by far the greatest explanatory "power" of any of the measures tested.

Besides being consistent with the stock market's taking a long-term, DCF approach to the valuation of companies, the authors' finding that investors seem to care most about earnings three to five years down the road has a number of important implications for financial management: First, a business unit doesn't necessarily create shareholder value if its return on capital exceeds the weighted average cost of capital - nor does an operation that fails to earn its WACC necessarily reduce value. To create value, the business's return must exceed what investors are expecting. Second, without forecasting returns on capital, management should attempt to give investors a clear sense of the firm's internal benchmarks, both for existing businesses and new investment. Third, management incentive plans should be based on stock ownership rather than stock options. Precisely because stock prices reflect expectations, the potential for prices to get ahead of realities gives options-laden managers a strong temptation to manipulate earnings and manage for the short term.

Suggested Citation

Copeland, Thomas E. and Copeland, Thomas E. and Dolgoff, Aaron D., Expectations-Based Management. Journal of Applied Corporate Finance, Vol. 18, No. 2, pp. 82-97, Spring 2006, Available at SSRN: https://ssrn.com/abstract=943544 or http://dx.doi.org/10.1111/j.1745-6622.2006.00089.x

Thomas E. Copeland (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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HOME PAGE: http://web.mit.edu/bin/cgicso?options=general&query=T+Copeland

CRA International ( email )

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HOME PAGE: http://www.crai.com/bio.asp?profid=29129

Aaron D. Dolgoff

Charles River Associates ( email )

John Hancock Tower
200 Clarendon Street, T-31
Boston, MA 02116-5092
United States
617-425-3623 (Phone)

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