The Effect of Macro Information Environment Change on the Quality of Management Earnings Forecasts

The 1990s were characterized by substantial increases in the performance of and investor reliance on financial analysts. Because managers possess superior private information and issue forecasts to align investors’ expectations with their own, we predict that managers increased the quality of their earnings forecasts during the 1990s in order to keep pace with the improved forward-looking information provided by financial analysts, upon which investors increasingly relied. Using a sample of 2,437 management earnings forecasts, we document an increase in management earnings forecast precision, management earnings forecast accuracy, and managers’ tendency to explain earnings forecasts in 1993-1996 relative to 1983-1986. Given that these forecast characteristics are linked to greater informativeness and credibility, we also document that the information content of management earnings forecasts, as measured by the strength of share price responses to forecast news, increased in 1993 -1996 relative to 1983-1986. As expected, the increased information content of management forecasts primarily occurred for firms covered by financial analysts

The Screening Effect of the Private Securities Litigation Reform Act

Prior research shows that the PSLRA increased the significance of merit-related factors, such as the presence of an accounting restatement or insider selling, in determining the incidence and outcomes of securities fraud class actions. (Johnson, Nelson, and Pritchard, 2007). This result, however, is consistent with two possible hypotheses. First, the PSLRA may have reduced solely the incidence of non-meritorious litigation. Second, the PSLRA may have changed the definition of merit, effectively precluding claims that would have survived and produced a settlement pre-PSLRA. This paper tests these alternative hypotheses. We find that pre-PSLRA claims that settled for nuisance value would be less likely to be filed under the PSLRA regime. We also find, however, that pre-PSLRA non-nuisance claims would be less likely to be filed post-PSLRA period. The latter result, which we refer to as the screening effect, is particularly pronounced for claims lacking obvious hard evidence indicia of fraud (an accounting restatement or an SEC investigation). This screening effect is stronger if the claims also lacked evidence of abnormal insider trading. By contrast, we find that pre-PSLRA claims with hard evidence or abnormal insider trading would be no less likely to be filed in the post-PSLRA period. We also examine the likelihood of settlement for pre-PSRLA claims if they had been filed in the post-PSLRA period, and find a similar screening effect for case outcomes. We conclude that Congress effectively changed the definition of merit in adopting the PSLRA, discouraging suits that would have produced a non-nuisance outcome prior to the law’s enactment

Strategy, Valuation, and Forecast Accuracy: Evidence from Italian Strategic Plan Disclosures

Using a sample of 264 strategic plan presentations by Milan Stock Exchange firms during 2001–2012, we present evidence of both a security price reaction and an increase in the accuracy of analysts’ earnings forecasts pursuant to plan disclosure. In the cross-section, the information content of the plan disclosures and the accuracy increase are incrementally associated with the extent of forward-looking narrative disclosures in the plan, after controlling for other disclosures within and outside the plan presentation and the fact that the firm has self-selected into the sample. Both quantitative and qualitative narrative disclosures are informative to investors and analysts. The results are driven by narrative disclosures about company strategy and action plans rather than about the business environment in which the company operates. Our study informs the current debate on the use of voluntary comprehensive, integrated, long-run-oriented strategic plan disclosure as a potential complement for disclosures such as quarterly earnings forecasts that have been described as an example of ‘short-termism’

Why Do Managers Explain Their Earnings Forecasts?

Managers often explain their earnings forecasts by linking forecasted performance to their internal actions and the actions of parties external to the firm. These attributions potentially aid investors in the interpretation of management forecasts by confirming known relationships between attributions and profitability or by identifying additional causes that investors should consider when forecasting earnings. We investigate why managers choose to provide attributions with their forecasts and whether the attributions are related to security price reactions to management earnings forecasts. Using a sample of 951 management earnings forecasts issued from 1993 to 1996, we find that attributions are more likely for larger firms, less likely for firms in regulated industries, less likely for forecasts issued over longer horizons, more likely for bad news forecasts, and more likely for forecasts that are maximum type. Furthermore, attributions are associated with greater absolute price reactions to management forecasts, more negative price reactions to management forecasts (forecast news held constant), and a greater price reaction per dollar of unexpected earnings. Our findings hold after control for the aforementioned determinants of attributions and after control for other firm- and forecast-specific variables that are often associated with security prices. Copyright University of Chicago on behalf of the Institute of Professional Accounting, 2004.

Trade Transparency and Management Earnings Forecasts

Employing a plausibly exogenous shock that increased the extent to which private information is revealed in debt markets – implementation of the Trade Reporting and Compliance Engine (TRACE) - we document a change in longer-run management earnings forecast policy. We find that managers decreased forecast frequency over the three-year period post-TRACE. The decline was greater for bad news management earnings forecasts, when the pre-disclosure information environment was weaker and for firms that were closer to credit default. These findings, taken in conjunction with prior findings of increases in earnings forecasting activity in response to declines in the strength of the information environment, suggest that the inverse relation between changes in the strength of the information environment and management earnings forecasting activity is symmetric. The finding that managers are also willing to curtail management earnings forecasting when the informational benefits of forecasting are reduced is significant given the actual and perceived costs of doing so. Our results also suggest that prior research understates the informational benefits of TRACE, per se, because of the decline in management earnings forecasting pursuant to TRACE

Macro information environment change and the quality of management earnings forecasts

Management forecasts, Information environment, Earnings quality, M40, M41, M49,