Browsing by Subject "earnings expectations"

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    How Changes in Expectations of Earnings Affect the Associations of Earnings Overstatements and Audit Effort with Audit Risk and Market Price
    (Wiley, 2022) Patterson, Evelyn R.; Smith, J. Reed; Tiras, Samuel L.; Kelley School of Business - Indianapolis
    In this study, we provide theoretical guidance for both analytical research and empirical research by considering how changing expectations of earnings affect a dishonest manager's strategy to overstate earnings and an auditor's strategy to exert effort in a two-period setting. We expect our study's insights on changing economic conditions to help shape future research. We model the manager type as either honest or dishonest, which allows us to differentiate audit risk from audit effort. The key takeaways for future research are the insights on how changes in payoffs and expected earnings affect the associations that involve earnings overstatements and audit effort with audit risk and market price. For instance, researchers typically assume audit effort and audit risk are negatively associated, but we find the association can be positive when, for example, the auditor chooses a period 2 strategy based on the changes in period 1 game parameters. The results of our study provide two additional key insights on the design of future empirical tests. First, by dichotomizing, we show the importance of estimating the intercept in the market pricing equation when studying earnings quality, because market price also adjusts for expected bias through changes in the intercept. Second, our multiperiod setting demonstrates that the effects from a change in the manager's or auditor's incentives in period 1 may reverse in period 2. Empirical studies typically examine the contemporaneous effects of these changes on market price and/or audit risk but fail to identify the cross-temporal effects we document in our study.
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    Stock Market Rewards for Earnings that Beat Analyst Earnings Forecasts when the Economy is Unforecastable
    (SSRN, 2021) Baik, Bok; Duong, Hong Kim; Farber, David B.; Shaw, Kenneth W.; Kelley School of Business - Indianapolis
    This study examines whether and why the stock market assigns an incremental premium to the act of beating analyst earnings forecasts when the economy is unforecastable. Our study uses a novel measure of macroeconomic (macro) uncertainty from Jurado et al. (2015) that captures periods during which the real economy is not forecastable and a regression model that controls for the forecast error throughout the quarter. Results show that during high macro uncertainty periods, the market assigns a greater premium to earnings that beat analyst earnings forecasts compared to the premium assigned to these earnings during low macro uncertainty periods. We also report a lower likelihood of managing earnings to beat analyst earnings forecasts during high macro uncertainty periods, suggesting higher accounting information quality. We further show that the incremental premium in high macro uncertainty periods is mainly concentrated within the group of firms that have both low liquidity risk and high accounting information quality. Evidence from our study should be relevant to those interested in understanding the usefulness of earnings during periods of extreme macro uncertainty and forces that determine accounting information quality.