Firms and Earnings Guidance

Understanding the formation of firms’ disclosure practices is of significant interest to regulators, managers, and investors. Anecdotal evidence and prior disclosure research generally conclude that firms’ current disclosure practices are often tightly connected to prior disclosure practices. However, prior disclosure practices must have a beginning in their own right, begging the questions of when and why disclosure practices begin. In our paper, When Do Firms Initiate Earnings Guidance? The Timing, Consequences, and Characteristics of Firms’ First Earnings Guidance, we examine when firms initiate earnings guidance (i.e., establish an earnings guidance policy) after an Initial Public Offering (IPO) and what factors are associated with the initiation decision.

Management earnings guidance is a key voluntary disclosure mechanism that has become increasingly prevalent. For example, the National Investor Relations Institute (NIRI) reports that 65% of companies that responded to their 2014 survey provide some form of earnings guidance (NIRI 2014). In addition, earnings guidance accounts for a large portion of the accounting-related information incorporated in stock prices (Beyer, Cohen, Lys, and Walther 2010). Therefore, it is important for regulators, investors, managers, and academics to understand how firms’ earnings guidance disclosure practices are formed and initiated. The initiation of earnings guidance is unique relative to other earnings guidance decisions in that guidance initiation precedes all other guidance decisions. Firms can continue, suspend, or stop earnings guidance at any point, but these decisions are only relevant for firms that have first initiated guidance in a prior period.

We explore questions related to when firms initiate earnings guidance by conducting three separate types of analyses on firms going public from 2001 to 2010 in order to provide insights on earnings guidance and voluntary disclosure theory. First, we examine how the timing of firms’ guidance initiation relates to various disclosure factors to better understand the costs and benefits of earnings guidance. Initiating guidance sets a disclosure precedent and firms that initiate guidance sooner after going public likely have different disclosure costs and benefits than those that initiate guidance more slowly or not at all. Overall, we find that about 73 percent of our sample of Initial Public Offering (IPO) firms initiate guidance and 31 (59) percent do so within 90 (365) days of going public. We expect firms to initiate guidance sooner if they are associated with influential external market participants, if their industry peers provide guidance, and if there is less uncertainty surrounding their IPOs (related to the quality of available information). Our results are generally consistent with these expectations.  We find that firms initiate guidance sooner when their IPO is backed by venture or private equity capital or when the firm has sell-side analyst coverage shortly after the IPO, consistent with external parties playing a significant role in disclosure formation. We find that firms initiate guidance sooner when more firms in their industry provide guidance, consistent with industry membership capturing the costs and benefits of earnings guidance. We also find evidence that firms with lower IPO information uncertainty provide earnings guidance sooner than firms with higher IPO information uncertainty.

Second, we explore stock returns around guidance initiations to (1) examine whether market participants rely on the information conveyed by first-time guidance and (2) consider factors likely associated with initial guidance credibility. This investigation allows us to examine market reactions to earnings guidance in a setting that avoids concerns about guidance history (i.e., the effects of prior guidance accuracy and bias on current guidance). Consistent with investors generally relying on firms’ first earnings guidance, we find a significantly positive association between abnormal returns and first guidance forecast news. Additionally, we find a stronger market response to earnings guidance when firms have external monitoring (i.e., venture capital), consistent with investors viewing the guidance of these firms to be more credible. We also find that earlier guidance is associated with a lower market response, consistent with the notion that investors view it to be less credible (perhaps because of concerns about its accuracy).

Third, we examine factors related to the periodicity (e.g., quarterly vs. annual), horizon, and specificity (e.g., point vs range) of firms’ initial guidance. We find that firms in more short-term (long-term) focused industries are more (less) likely to provide quarterly first guidance and first guidance that has a shorter horizon. We find very little evidence that the other factors we study are associated with first guidance horizon. The basic tenor of these results suggests that, while the timing of first guidance varies with firm-specific measures of the costs and benefits of disclosure predicted by theory, the periodicity and horizon of first guidance depend mostly on industry factors. Finally, we examine factors associated with the specificity of a firms’ first guidance (i.e., whether they are point, range, min, or max forecasts). We find that firms with venture capital and equity backing provide more specific first guidance. Interestingly, we find that firms are more likely to provide more specific earnings guidance if they are part of a short-term focused industry. Also, we find some evidence that firms with less IPO information uncertainty provide more specific guidance.

Overall, our results contribute to the disclosure literature by providing evidence on the formation of firms’ disclosure policies. As noted by Leuz and Verrecchia (2000), most prior disclosure studies examine decisions to provide a disclosure rather than decisions about disclosure policy. We examine when firms initiate earnings guidance (i.e., establish an earnings guidance policy) after an IPO and what factors are associated with this initiation decision. Our results are particularly important given evidence that earnings guidance decisions are “sticky” and that prior earnings guidance decisions often set a precedent for future guidance disclosures. We find that the timing, market response, and characteristics of initial earnings guidance after going public are associated with proxies for prestigious external parties, industry membership, and IPO information uncertainty, consistent with theories about the costs and benefits of voluntary disclosure.

The full paper is available for download here.