Management forecast credibility and underreaction to news
- 3.3k Downloads
In this paper, we first document evidence of underreaction to management forecast news. We then hypothesize that the credibility of the forecast influences the magnitude of this underreaction. Relying on evidence that more credible forecasts are associated with a larger reaction in the short window around the management forecasts and a smaller post-management forecast drift in returns, we show that the magnitude of the underreaction is smaller for firms that provide more credible forecasts. Our paper contributes to the literature by providing out-of-sample evidence of the drift in returns documented in the post-earnings-announcement drift literature, with the credibility of the news being one explanation for the phenomenon.
KeywordsMarket efficiency Credibility Voluntary disclosure
JEL ClassificationG12 G14 G30 M41
We thank Brian Bushee, Gavin Cassar, Tarun Chordia, Vicki Dickinson, S.P. Kothari, Ryan LaFond, Kin Lo, Rick Mendenhall, Ray Pfeiffer, Scott Richardson, Jonathan Rogers, Tjomme Rusticus, Praveen Sinha, Siew Hong Teoh, Joseph Weber, and workshop participants at Barclays Global Investors, University of California at Berkeley, Bristol University, Lancaster University, London Business School, University of Mannheim, University of Minnesota, MIT, Tilburg University, 2006 FEA conference, 2007 FARS Midyear Meeting, 2007 Maryland Finance Symposium, 2007 WFA conference, and 2007 AAA conference for their helpful comments. We appreciate financial support from the London Business School, the MIT Sloan School of Management, and the Wharton School. Jeffrey Ng and Rodrigo Verdi are also grateful for financial support from the Deloitte & Touche Foundation.
- Baginski, S., Conrad, E., & Hassell, J. (1993). The effects of management forecast precision on equity pricing and on the assessment of earnings uncertainty. The Accounting Review, 68, 913–927.Google Scholar
- Drake, M., Myers, J., & Myers, L. (2009). Disclosure quality and the mispricing of accruals and cash flows. Journal of Accounting, Auditing & Finance, 24, 357–384.Google Scholar
- Foster, G., Olsen, C., & Shevlin, T. (1984). Earnings releases, anomalies and the behavior of security returns. The Accounting Review, 59, 574–603.Google Scholar
- Frankel, R., McNichols, M., & Wilson, G. P. (1995). Discretionary disclosure and external financing. The Accounting Review, 70, 135–150.Google Scholar
- Hutton, A., & Stocken, P. (2009). Prior forecasting accuracy and investor reaction to management earnings forecasts. Working paper, Boston College and Dartmouth College.Google Scholar
- McNichols, M. (1989). Evidence of information asymmetries from management earnings forecasts and stock returns. The Accounting Review, 64, 1–27.Google Scholar
- Rogers, J., & Van Buskirk, A. (2009). Bundled forecasts and selective disclosure of good news. Working paper, University of Chicago.Google Scholar
- Sloan, R. (1996). Do stock prices fully reflect information in accruals and cash flows about future earnings? The Accounting Review, 71, 289–315.Google Scholar
- Williams, P. (1996). The relation between a prior earnings forecast by management and analyst response to a current management forecast. The Accounting Review, 71, 103–113.Google Scholar