Wednesday, May 7, 2014

Believe it or not: Managerial Discretion and Security Analysts’ Responses to Management Earnings Guidance

CHEN Guoli, CROSSLAND Craig
Believe it or not: Managerial Discretion and Security Analysts’ Responses to Management Earnings Guidance in Finance and Strategy (Advances in Strategic Management, Vol. 31), Belen Villalonga (Ed.) (forthcoming)

Financial analysts act as crucial conduits of information between firms and stakeholders. However, comparatively little is known about how these information intermediaries evaluate the believability and importance of corporate disclosures. We argue that a firm’s level of managerial discretion, or latitude of executive action, acts as a cue for financial analysts, which helps them interpret and respond to voluntary management earnings forecasts. Our study provides strong, robust evidence that financial analysts find management forecasts significantly less believable in low-discretion than in high-discretion environments, and therefore tend to be much less responsive to these forecasts. We also show that managerial discretion is especially impactful on analysts’ responses in those circumstances where analysts are typically most uncertain about how to interpret management forecasts.