Management earnings expectations, earnings uncertainty, and voluntary disclosure of earnings forecasts by management : an empirical evaluation of current disclosure practices under the voluntary rules

Date

1987

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Abstract

There has been an intensive debate in the accounting profession and the Investment community regarding whether companies should be required to disclose managerial earnings forecasts. The SEC Initially considered a mandatory forecast disclosure rule, but due to the several technical and legal problems adopted a voluntary rule. As a result, corporate managers may publish their earnings forecasts In SEC filings or In annual reports at their discretion. One of the main arguments for the mandatory rule was that, under the voluntary rule, managers are likely to disclose good news forecasts and withhold bad news forecasts relative to the market expectations of earnings. Thus, Investors would always be able to have access to only favorable and good news forecasts. In response to these arguments, the opponents of the mandatory rule contended that corporate managers with highly volatile earnings would provide misleadingly conservative forecasts because they would be concerned with a legal liability which might result from unduly optimistic forecasts. The primary objective of this study Is to address two different but related questions. First, do corporate managers willingly disclose favorable earnings forecasts and withhold unfavorable earnings forecasts relative to the market expectations of earnings? Second, does earnings uncertainty have any Impact on the managers' disclosure patterns of earnings forecasts? With respect to the first question, the results of this study provide mixed evidence depending upon the different model specification of the market expectations of earnings. When the time-series models exclusively based on the past history of actual earnings were employed to estimate the market expectations of earnings, the findings of this study support the "conventional wisdom" that corporate managers disclose good news forecasts and withhold bad news forecasts. When the financial analysts' forecasts were employed to estimate the market expectations of earnings, however, such asymmetrical disclosure practices could not be detected, and hence, on the average, a full disclosure is made under the voluntary mechanism. This mixed evidence Implies that It may be unwarranted to Impose a mandatory disclosure rule for the purpose of equitable and timely dissemination of forecast information without better knowledge of the formation of earnings expectations by investors. Any conclusion about the desirability of such a rule should not be reached until convincing evidence on the formation of earnings expectations by Investors Is revealed. With regard to the second question, the results of this study appear to Indicate that earnings uncertainty has no impact on the managers' disclosure patterns of earnings forecasts. These findings suggest that corporate managers whose firms' earnings are very volatile and unpredictable, do not provide misleadingly conservative forecasts because of their concern with the potential legal risk. However, these results should be interpreted with caution. Since the sample of this study includes only earnings forecasts voluntarily disclosed by corporate managers, such results may not necessarily hold true when a mandatory rule is imposed on all companies.

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Keywords

Profit--Accounting, Disclosure in accounting, Financial statements

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