FIU Business Now Magazine Spring 2024
Overly Cautious Earnings Guidance Delivers Short-lived Benefits for Businesses 

Overly Cautious Earnings Guidance Delivers Short-lived Benefits for Businesses

By Cynthia Corzo

Stock performance for companies engaging in lowball guidance — forecasting earnings that are substantially lower than actual numbers — improves only in the first four quarters after the initiation of these episodes, a new study from FIU Business shows.

Researchers found that the likelihood of meeting and beating analyst consensus also dissipates after four quarters and that while episodes of lowball guidance likely appeal to certain types of market participants in the short term, they aren't sustainable.

"Companies may want to give a slightly conservative forecast, to under-promise and over-deliver in order to keep stock prices higher," said Michael (Minye) Tang, associate professor of accounting at FIU Business and one of the researchers. "Sometimes these forecasts turn out to be too conservative if the exceptionally high growth of the firm even surprises the CEO."

Forthcoming in the British Accounting Review, the research provides two explanations for lowball guidance episodes: firms' earnings uncertainty, and to a lesser extent, their attempts to appease sell-side analysts and institutional investors.

"When facing an uncertain path of growth, managers tend be conservative in their forecasts because the costs of missing their own guidance outweigh the benefits of over-promising," said Tang.

He pointed out that the sample in their study includes a considerable number of high-profile S&P 500 companies known for this practice. Among them are Apple, Netflix, LinkedIn, Qualcomm, Target, Marriott, Procter & Gamble and General Motors, which as a group represent a significant portion of the overall U.S. stock market valuation and the economy.

The researchers put together a sample of 2,953 companies and examined a total of 118,132 firm-quarters of earnings guidance from 2001 - 2017. Of those companies, 329 were identified as lowball firms at some point during the sample period.

The study also found that lowball guidance is a recurring behavior – of the 293 firms that stopped lowball guidance, 94 restarted at least one more episode, 57 firms had two episodes, 24 had three, 11 firms had four, and two firms had five episodes.

"Our study is the first to systematically document the prevalence of the wellknown phenomenon of lowball guidance," said Tang, "and to assess economic explanations and market consequences of this practice that distinguish it from the general notion of simply meeting or beating market earnings expectations."

Tang conducted the research with Jing Chen of the Stevens Institute of Technology, and Michael J. Jung of the University of Delaware.