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Abstract

This paper studies the use of management earnings forecasts (MEF) to dampen analysts' expectations, i.e. expectation management, by Chinese listed companies. We reveal several important findings: Firstly, information asymmetry is positively associated with the use of MEF to dampen analysts' expectations. State control has been found to moderate this relationship. Secondly, dampening analysts' expectations using MEF leads to negative stock return reactions and downward analysts' forecast revisions. Thirdly, the effectiveness of “pre-empting bad news through MEF” appears mixed and dependent on the information content of MEF and measures of actual earnings surprises. Finally, firms that disclose MEF are found to engage in more earnings management to meet the forecasts than firms that do not.

5. Conclusion

This paper extends the management earnings forecast literature by examining the use of MEF to dampen analysts' expectations, i.e. expectation management, under the special institutional environment in China. As the majority of the Chinese listed companies are carve-outs from state-owned enterprises during China's privatization process, more than half of the listed companies in China today are under control of the Chinese government. Studying MEF disclosures by Chinese firms has a meaningful contribution to this literature because government association has important influence on firms' information environment and performance. We document that information asymmetry measured by the quality of analysts' forecasts prior to MEF disclosures is positively associated with expectation management and government control moderates this relationship. This finding supports the view that inferior information environment motivates firms to engage in expectation management but state influence moderates this effect due to SOEs' weaker incentives to meet analyst expectations. Consistent with prior studies on US firms, we also find that dampening analyst expectations using MEF leads to negative stock market reactions and downward analysts' forecast revisions. However, the effectiveness of “pre-empting bad news through MEF” in China appears mixed and dependent on measures of actual earnings surprises and the information content in MEF. Therefore, firms should be cautious of the consequences of expectation management. For instance, our results indicate that disclosing the categories of MEF is often not as effective as providing range or point earnings forecasts. Finally, we find that MEF disclosure firms engage in more earnings management to meet the forecasts. Investors must remain vigilant when incorporating MEF into their portfolio strategies. Regulators need to consistently adopt policies aimed at strengthening corporate governance and institute rules to ensure financial reporting quality while enforcing MEF disclosures.