Earnings management and forecast guidance as mechanisms to meet or beat analysts\u27 earnings forecasts

Firms can use both earnings management and forecast guidance to meet or beat analysts\u27 earnings forecasts. I provide preliminary evidence that earnings management is used increasingly over time, but forecast guidance is not used increasingly over time, together with firms\u27 increasing propensities to meet or beat analysts\u27 earnings forecasts. This motivates me to examine (1) whether earnings management or forecast guidance is used as a mechanism to meet or beat analysts\u27 earnings forecasts; (2) why firms do not use forecast guidance increasingly over time. For the first research question, I examine whether earnings management and forecast guidance are influenced by context-specific factors such as accounting flexibility and information asymmetry. As earnings management is not a limitless mechanism and the mechanics of accrual accounting places a certain degree of constraint on this mechanism, I expect that firms with less accounting flexibility in the sense that they are more constrained to manage earnings, are less likely to use earnings management as a mechanism. Furthermore, I expect that firms with greater information asymmetry are more likely to use forecast guidance to meet or beat analysts\u27 earnings forecasts. I consider the gap between unmanaged earnings and unguided analysts\u27 earnings forecasts as the information asymmetry between management andanalysts. For the empirical analysis, I consider net operating assets as a proxy for earnings management constraint (Barton and Simko 2002) and market-to-book ratios as a proxy for information asymmetry (Lev 2001). Using firm-quarters spanning from 1993 to 2002, I find evidence that supports my conjectures. This shows that context-specific factors influence the choice of earnings management and forecast guidance as mechanisms to meet or beat analysts\u27 earnings forecasts, which helps to partially reconcile mixed results about whether earnings management and forecast guidance are mechanisms to meet or beat analysts\u27 earnings forecasts. For the second research question, I consider the market response to negative forecast revisions as the cost of providing downward forecast guidance. I show that the cost of providing downward forecast guidance increased using individual analyst forecast revisions from 1993 to 2002. This provides a rationale for why firms do not use forecast guidance increasingly over time while firms increasingly meet or beat analysts\u27 earnings forecasts