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Do firms use early guidance to disclose the effect of conservatism on future earnings?

Do firms use early guidance to disclose the effect of conservatism on future earnings? By deferring profits and anticipating losses, conservatism makes earnings increases more persistent and earnings declines more likely to revert. Therefore, the level of conservatism in current earnings has implications for future earnings expectations. Past research shows that outsiders can fail to understand these implications. This paper aims to investigate whether firms help outsiders by voluntarily disclosing their expectations about how conservatism will affect future earnings trends.Design/methodology/approachThe authors examine the likelihood and content of “early” earnings guidance – i.e. guidance about future earnings that is released around or before the announcement of current earnings. The sample is made of 8,820 annual earnings announcements, 62 per cent of which are combined with early guidance.FindingsThe authors find that the more conservative current earnings, the higher: the likelihood that the firm releases early guidance; the likelihood that the firm predicts a positive change in earnings; and the difference between the forecasted earnings and current earnings. The authors also find such guidance to be relevant to analysts, who use it to update their forecasts.Practical implicationsBy showing that firms use early guidance to disclose the effect of conservatism on future earnings, the study is interesting to users and preparers because it shows that analysts need and use such disclosure; and regulators because it alleviates concerns about the information consequences of conservatism.Originality/valueThe findings show that firms do not refrain from committing to positive early guidance to disclose the earnings effects of conservatism. This is interesting in light of the difficulty of predicting such effects, the manager incentives to keep expectations low and the cost of committing to positive guidance instead of less risky qualitative disclosure alternatives. In this way, the authors contribute to the literature on the interrelation between voluntary disclosure and conservatism in financial reports. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting and Finance Emerald Publishing

Do firms use early guidance to disclose the effect of conservatism on future earnings?

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References (66)

Publisher
Emerald Publishing
Copyright
© Emerald Publishing Limited
ISSN
1475-7702
DOI
10.1108/raf-09-2018-0203
Publisher site
See Article on Publisher Site

Abstract

By deferring profits and anticipating losses, conservatism makes earnings increases more persistent and earnings declines more likely to revert. Therefore, the level of conservatism in current earnings has implications for future earnings expectations. Past research shows that outsiders can fail to understand these implications. This paper aims to investigate whether firms help outsiders by voluntarily disclosing their expectations about how conservatism will affect future earnings trends.Design/methodology/approachThe authors examine the likelihood and content of “early” earnings guidance – i.e. guidance about future earnings that is released around or before the announcement of current earnings. The sample is made of 8,820 annual earnings announcements, 62 per cent of which are combined with early guidance.FindingsThe authors find that the more conservative current earnings, the higher: the likelihood that the firm releases early guidance; the likelihood that the firm predicts a positive change in earnings; and the difference between the forecasted earnings and current earnings. The authors also find such guidance to be relevant to analysts, who use it to update their forecasts.Practical implicationsBy showing that firms use early guidance to disclose the effect of conservatism on future earnings, the study is interesting to users and preparers because it shows that analysts need and use such disclosure; and regulators because it alleviates concerns about the information consequences of conservatism.Originality/valueThe findings show that firms do not refrain from committing to positive early guidance to disclose the earnings effects of conservatism. This is interesting in light of the difficulty of predicting such effects, the manager incentives to keep expectations low and the cost of committing to positive guidance instead of less risky qualitative disclosure alternatives. In this way, the authors contribute to the literature on the interrelation between voluntary disclosure and conservatism in financial reports.

Journal

Review of Accounting and Finance – Emerald Publishing

Published: Aug 9, 2019

Keywords: Voluntary disclosure; Accounting conservatism; Earnings guidance

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