Forward-Looking Earnings Statements: Determinants and Market Response

Abstract

This paper identifies cross-sectional factors that motivate the disclosure of forward-looking earnings information and documents that these disclosures impact market prices by "pulling forward" future earnings information. We examine a set of firms facing poor current earnings performance, undervaluation concerns, investor neglect and extreme pessimism and find significant cross-sectional variation regarding whether these firms provide forward-looking earnings information to correct market misperceptions in advance of the earnings announcement. Consistent with existing theory, firms with stronger and more persistent earnings news are more likely to provide forward-looking disclosures during the turnaround period. Moreover, we find that firms operating in high litigation industries, possessing strong institutional ownership, having greater stock option-based compensation and facing larger non-equity stakeholders are more likely to provide disclosures. Alternatively, we find evidence that the use of alternative financial signaling mechanisms (share repurchases and dividend increases) lowers the probability that managers will make forward-looking disclosures. Market-based tests indicate that the disclosed information is value-relevant. The market responds in a significantly positive manner to forecasts of earnings (i.e., forward-looking statements provided outside of earnings announcements) as well as to forward-looking statements bundled in current earnings announcements (after controlling for the current period's earnings information). Furthermore, these responses are positively correlated with future seasonally-adjusted changes in earnings, indicating the disclosures are effective in pulling forward future mandatory information. Finally, the market reaction to the announcements of previously preempted earnings is less than that of unpreempted earnings, providing additional evidence that the disclosures are effectively pulling-forward the eventual mandatory earnings information.

JEL Classification: M41, M45, G12, G14