Ping Wang is Assistant Professor of Accounting at Pace University Lubin School of Business. This post is based on a recent article by Professor Wang; Masako N. Darrough, Professor of Accountancy at Baruch College/CUNY Zicklin School of Business; and Linna Shi, Assistant Professor of Accounting at SUNY Binghamton. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).
When faced with an impending negative earnings surprise, CEOs have to decide whether or not to voluntarily issue earnings warnings. A warning (defined as negative earnings guidance) might be issued when a firm expects that its actual earnings will fall short of existing market expectations. Such a warning is typically issued near or after the end of a fiscal quarter, but before quarterly or annual earnings are announced. The extant literature on U.S. firms documents a number of reactions to the issuance of an earnings warning, including: an adjustment by the market of its expectations, typically through a reduction in share prices; a decrease in litigation costs; less information asymmetry among investors; increased analyst following; and increased chances of meeting or beating analysts’ forecasts. Given that these firms tend to be performing poorly (or at least below market expectations), the issuance of warnings appears to be an integral part of the timely disclosure of bad news.