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Does the Stock Market See a Zero or Small Positive Earnings Surprise as a Red Flag?

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  • EDMUND KEUNG
  • ZHI‐XING LIN
  • MICHAEL SHIH

Abstract

This study shows that firms collectively incur a cost for managing earnings and analyst expectations to meet earnings forecasts. We compare the coefficient in the regression of abnormal stock returns on earnings surprise (the earnings response coefficient [ERC]) across ranges of earnings surprises. The ERC for earnings surprises in the range [0, 1¢] is significantly lower than ERCs for earnings surprises in adjacent ranges for firm‐quarters in the early and mid 2000s, but not for those in the 1990s. The results are robust to controlling for the sign of estimated discretionary accruals and the trajectory of analyst earnings forecasts. We further find that investors are right to be skeptical about earnings surprises in the range [0, 1¢]. The relation of future earnings surprise with current earnings surprise is more negative for current earnings surprises in that range than for those in any other range. Evidence also suggests analysts react negatively to earnings surprises in that range.

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  • Edmund Keung & Zhi‐Xing Lin & Michael Shih, 2010. "Does the Stock Market See a Zero or Small Positive Earnings Surprise as a Red Flag?," Journal of Accounting Research, Wiley Blackwell, vol. 48(1), pages 105-136, March.
    • Handle: RePEc:bla:joares:v:48:y:2010:i:1:p:105-136
    DOI: 10.1111/j.1475-679X.2009.00354.x
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    2. Kristina Minnick, 2011. "The role of corporate governance in the write‐off decision," Review of Financial Economics, John Wiley & Sons, vol. 20(4), pages 130-145, November.
    3. Sun, Zeyu & Kong, Ningning & Wu, Lei & Bao, Yu, 2024. "Does contingent payment in M&As induce acquirers’ earnings management? Evidence from performance commitment," Research in International Business and Finance, Elsevier, vol. 69(C).
    4. Albert Tsang & Yi Xiang & Miao Yu, 2023. "Cross‐border regulatory enforcement and corporate voluntary disclosure," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 50(3-4), pages 482-523, March.
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    6. Itay Kama & Dan Weiss, 2013. "Do Earnings Targets and Managerial Incentives Affect Sticky Costs?," Journal of Accounting Research, Wiley Blackwell, vol. 51(1), pages 201-224, March.
    7. Sanjay W. Bissessur & David Veenman, 2016. "Analyst information precision and small earnings surprises," Review of Accounting Studies, Springer, vol. 21(4), pages 1327-1360, December.
    8. Shih, Michael, 2019. "Investor skepticism and the incremental effects of small positive sales surprises," Journal of Economics and Business, Elsevier, vol. 106(C).
    9. David Veenman & Patrick Verwijmeren, 2022. "The Earnings Expectations Game and the Dispersion Anomaly," Management Science, INFORMS, vol. 68(4), pages 3129-3149, April.
    10. Vincent Chen & Samuel Tiras, 2015. "‘Other information’ as an explanatory factor for the opposite market reactions to earnings surprises," Review of Quantitative Finance and Accounting, Springer, vol. 45(4), pages 757-784, November.
    11. Qazi Ghulam Mustafa Qureshi & Yves Mard & François Aubert, 2022. "Effects of earnings management on firms' marketadjusted return," Post-Print hal-04266643, HAL.
    12. Lawrence Brown & Kelly Huang & Arianna Pinello, 2013. "To beat or not to beat? The importance of analysts’ cash flow forecasts," Review of Quantitative Finance and Accounting, Springer, vol. 41(4), pages 723-752, November.
    13. Bird, Andrew & Karolyi, Stephen A. & Ruchti, Thomas G., 2019. "Understanding the “numbers game”," Journal of Accounting and Economics, Elsevier, vol. 68(2).
    14. Hsieh, Su-Jane & Su, Yuli, 2015. "The economic implications of the earnings impact from lease capitalization," Advances in accounting, Elsevier, vol. 31(1), pages 42-54.
    15. Jeffery Abarbanell & Hyungshin Park, 2017. "Do Bright-Line Earnings Surprises Really Affect Stock Price Reactions?," Management Science, INFORMS, vol. 63(4), pages 1063-1084, April.
    16. Camillo Lento & Julie Cotter & Irene Tutticci, 2016. "Does the market price the nature and extent of earnings management for firms that beat their earnings benchmark?," Australian Journal of Management, Australian School of Business, vol. 41(4), pages 633-655, November.
    17. Minnick, Kristina, 2011. "The role of corporate governance in the write-off decision," Review of Financial Economics, Elsevier, vol. 20(4), pages 130-145.
    18. Xia, Jingjing, 2023. "Redrawing the line: Narrowly beating analyst forecasts and journalists’ co-coverage choices in earnings-related news articles," Journal of Contemporary Accounting and Economics, Elsevier, vol. 19(3).
    19. Phillip J. Quinn, 2018. "Shifting corporate culture: executive stock ownership plan adoptions and incentives to meet or just beat analysts’ expectations," Review of Accounting Studies, Springer, vol. 23(2), pages 654-685, June.
    20. Leonidas Enrique de la Rosa & Nikolaj Kirkeby Niebuhr, 2019. "Loss aversion and the zero-earnings discontinuity," Economics Working Papers 2019-09, Department of Economics and Business Economics, Aarhus University.
    21. Harris, David G. & Shi, Linna & Xie, Hong, 2018. "Does benchmark-beating detect earnings management? Evidence from accounting irregularities," Advances in accounting, Elsevier, vol. 41(C), pages 25-45.
    22. Paul A. Griffin & David H. Lont, 2021. "Evidence of an increasing trend in earnings surprises over the past two decades: The role of positive manager‐initiated non‐GAAP adjustments," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 48(9-10), pages 1525-1559, October.
    23. He, Wen & Li, Yan, 2020. "Comparing with the average: Reference points and market reactions to above-average earnings surprises," Journal of Banking & Finance, Elsevier, vol. 117(C).

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