An experimental investigation of investors' and analysts' reactions to management guidance.
Tan, Hun Tong.
Hunton, James E.
Date of Issue2004
College of Business (Nanyang Business School)
Cornell University, Bentley College, Universiteit Maastricht
This study examines how the form of managements’ earnings guidance (point, narrow range, wide range) affects analysts’ earnings forecasts. Results from two experiments demonstrate that: (1) guidance form has no effect on analysts’ forecasts made immediately after the guidance; and (2) after the actual earnings announcement, guidance form and the relationship of the earnings guidance to actual earnings (guidance error) interact in their effect on analysts’ forecasts. After the actual earnings announcement, guidance error leads to higher (lower) analysts’ forecasts for firms with downwardly (upwardly) biased guidance; this effect of guidance error is magnified by a narrow range and reduced by a wide range, compared to a point estimate. These results suggest that treating the mean of the range endpoints as equivalent to a point estimate and failing to consider effects after the release of actual earnings may paint an incomplete picture of how management guidance affects analysts and investors. It also offers useful information to managers who issue earnings guidance, and presents a challenge to the psychology literature regarding the effects of information precision on judgment and decision making.