Jens Stephan

Purpose: The purpose of this study is to use implied volatilities from exchange traded options to examine the interaction between analysts’ forecast revisions and the market’s perception of uncertainty about firm value. Design/methodology/approach: The authors examine how characteristics of individual forecast revisions, e.g. news and changes in dispersion of forecasts, affect changes in implied volatilities, whether analysts use the observable changes in implied volatilities to inform their forecast revisions and whether changes in dispersion of forecasts are correlated with changes in implied volatilities. Findings: The authors find that good (bad) news forecast revisions reduce (increase) investors’ perception of uncertainty about firm value, analysts do not appear to use changes in implied volatilities to shade their forecast revisions to good/bad news and dispersion of forecasts are a reasonable proxy for uncertainty about firm value as indicated by their correlation with implied volatilities. Originality/value: Recent research on analysts’ forecast revisions and management forecasts has focused on risk perception rather than value. This paper extends this work with a risk metric based on market transactions in both a short and long window analysis, as well as univariate and multivariate analysis.

Purpose: The purpose of this paper is to document at the firm-specific level whether firms manage earnings up or down to barely miss or meet/beat three common earnings threshold targets, namely, analysts’ forecasts (AFs), last year’s earnings and zero earnings, and whether the market rewards or punishes up versus down earnings management. Design/methodology/approach: The authors assign each firm to its most likely earnings target using an algorithm that reflects management’s economic incentives to manage earnings. The authors place reported (managed) earnings in standard width intervals surrounding the earnings target. Jacob and Jorgensen’s (2007) proxy for unmanaged earnings is also placed into the intervals. Thus, a firm with unmanaged earnings in the interval just below the target and reported earnings in the interval just above the target would be deemed to have managed earnings up. The authors also document whether the market rewarded or punished the earnings management strategy with three-day cumulative abnormal returns. Findings: The authors find that most firms which barely meet/beat their target did so by managing earnings up. The market rewarded this earnings management strategy. The market did not, however, reward firms that managed earnings down (i.e. created a cookie jar of reserves) to barely meet/beat their target. Thus, the meet/beat premium does not apply to all firms. The authors’ explanation is that most earnings targets are set by AFs; that these are usually the highest of the three targets; and that these are, therefore, considered to be “good” firms by the market because they have the ability to find that extra penny to meet/beat the target. Firms that were assigned to the last year’s earnings and/or zero earnings thresholds are not as “good” because they usually do not target the highest threshold and must manage earnings down, as they are more likely to have to reverse income-increasing accruals booked during interim quarters. Research limitations/implications: The primary limitation in this study is the algorithm used to assign firms to their threshold target. It is ad hoc in nature, but relies on reasonable assumptions about the management’s incentives to manage earnings. Practical implications: This study has practical implications because investors and regulators can adopt this methodology to identify potential candidates for earnings management that would allow further insight into accounting and reporting practices. This methodology may also be useful to the auditor who wants to understand the tendencies of a new client. It may also be a useful tool for framing auditing hypotheses in a way that would be appropriate for clients who manage earnings. Originality/value: This paper documents for the first time at the firm-specific level the market reaction to upward versus downward earnings management designed to barely meet/beat the earnings threshold. It also documents the frequency with which firms target the three earnings thresholds and the frequency with which firms miss or meet/beat their threshold.