When Do Firms Initiate Earnings Guidance? The Timing, Consequences, and Characteristics of Firms’ First Earnings Guidance
University of Wisconsin – Madison
Up-and-Coming Small- and Mid-cap Portfolio Managers #MICUS (Morningstar Conference)
Brigham Young University – Marriott School of Management
Illinois State University – College of Business
Cornell University – Samuel Curtis Johnson Graduate School of Management
The decision to provide earnings guidance for the first time is an important disclosure decision that has a significant effect on subsequent earnings guidance decisions. We explore how soon managers initiate earnings guidance after an initial public offering (IPO) and the factors associated with the adoption of this new disclosure policy. Our results suggest that managers in the current environment often initiate public guidance soon after their IPOs. Specifically, we find that more than 31 (59) percent of our sample firms provide earnings guidance within 90 (365) days of going public. We explore factors that are likely related to the supply of and demand for early earnings guidance. We find evidence of a positive association between the timing of earnings guidance initiation and the involvement of influential external parties (analysts, venture capital firms, and private equity firms) and the proportion of industry peers that guide and a negative association between the timing of first guidance and IPO information uncertainty. In addition, we find a positive association between abnormal returns and first guidance forecast news, consistent with investors generally relying on first-time guidance. We also find that firms in short-term focused industries tend to provide shorter-horizon initial guidance. Overall, the results indicate that, while the timing of first guidance varies with firm-specific measures of the costs and benefits of disclosure predicted by theory, the horizon of first guidance depends mostly on industry factors.
When Do Firms Initiate Earnings Guidance? The Timing, Consequences, and Characteristics of Firms’ First Earnings Guidance – Introduction
Management earnings guidance is a key voluntary disclosure mechanism that has become increasingly prevalent. The National Investor Relations Institute (NIRI) reports that 65% of companies that responded to their 2014 survey provide some form of earnings guidance (NIRI 2014). In addition, earnings guidance accounts for a large portion of the accounting-related information incorporated in stock prices (Beyer, Cohen, Lys, and Walther 2010).1 Given its importance, numerous academic studies seek to understand firms’ earnings guidance behavior. These studies have generally concluded that prior earnings guidance behavior is the most important factor in predicting future earnings guidance (e.g., Williams 1996; Hutton and Stocken 2009; Feng and Koch 2010). This evidence is consistent with the notion that once a firm begins providing guidance, there is a strong expectation that it will continue to do so (Acito 2011; Tang 2015). Thus, natural questions arise as to when firms begin providing earnings guidance and how it is received by the market. We address these questions by providing the first empirical evidence regarding firms’ decisions to initiate earnings guidance.
The initiation of earnings guidance is unique relative to other earnings guidance decisions. Initiation precedes all other guidance decisions. Hence, first-time earnings guidance provides an opportunity to examine how external market participants view firms’ guidance disclosure policies. Firms can continue, suspend, or stop earnings guidance at any point, but these decisions are only relevant for firms that have initiated guidance in a prior period. Despite the significance of the guidance initiation decision for firms’ disclosure policies, there is little empirical evidence on this phenomenon. We explore this issue by conducting three separate types of analyses to provide new insights on earnings guidance and voluntary disclosure theory. First, we examine how the timing of firms’ guidance initiations relates to various disclosure factors to better understand the costs and benefits of earnings guidance. Initiating guidance sets a disclosure precedent and firms that initiate guidance sooner likely have different disclosure costs and benefits than those that initiate guidance more slowly or not at all. Second, we explore stock returns around guidance initiations to (1) examine whether market participants rely on the information conveyed by first-time guidance and (2) consider factors likely associated with initial guidance credibility. This investigation allows us to examine market reactions to earnings guidance in a setting that avoids concerns about guidance history (i.e., the effects of prior guidance accuracy and bias on current guidance). Third, we examine factors related to the periodicity (e.g., quarterly vs. annual), horizon, and specificity (e.g., point vs range) of firms’ initial guidance. These analyses help us explore whether firms’ initial guidance behavior relates to managerial short-termism as well as the precision of management information.
To perform these analyses, we construct a sample of firms going public between January 2001 and December 2010. We begin our sample period in 2001 to avoid systematic changes in regulation and guidance practice. We expect public earnings guidance to be more important following the implementation of Regulation Fair Disclosure (Reg FD) in 2000 because it prohibits private guidance (Heflin, Subramanyam, and Zhang 2003; Wang 2007). We examine all public press releases beginning with each firm’s IPO date and follow their disclosures through their lifetime as public companies to identify their first instance of earnings guidance. Earnings forecasts are rarely, if ever, disclosed in the IPO prospectuses of firms listed on U.S. stock exchanges.2 Hence, public earnings guidance generally begins sometime after the IPO, which enables us to utilize the unique post-IPO setting to examine firms’ first earnings guidance. Overall, we find that about 73 percent of our sample IPO firms initiate guidance and 31 (59) percent do so within 90 (365) days of going public.
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