Earnings patterns and managerial guidance

This study examines whether the presence of patterns in a firm’s earnings history, namely: strings of earnings increases or decreases and breaks in such strings, affects the likelihood and outcomes of management issued guidance. We find that, consistent with increased demand for information about changes in established earnings patterns, firms are more likely to issue guidance before breaks in patterns. For continuing strings, disclosure choices depend on the nature of news: while firms are less likely to issue guidance for strings of decreases, they actively guide for strings of increases after Regulation Fair Disclosure (Reg FD). Our results indicate that management guidance before negative breaks in patterns is incorporated in stock prices upon issuance, and consequently attenuates the market reaction during earnings announcements. However, we fail to find evidence of market reaction to guidance issuances for positive break news, which investors may view as less credible. Overall, we conclude that while firms appear to issue guidance strategically, investors do not fully incorporate the information from management in stock prices. Our findings are consistent with the litigation hypothesis of greater disclosure to avoid litigation risk associated with changes in earnings patterns, and only partially support the claim that management guidance may reduce information asymmetry associated with break events.