Abstract

During the 1990s, the number of firms that were able to meet or beat analysts' expectations (MBE) steadily increased. The accounting literature documents that firms MBE by managing earnings upward and/or by managing expectations downward. Using a comprehensive sample from 1999--2003, I investigate whether the market reacts differently to the strategies used by managers to MBE. I also examine the impact that Regulation Fair Disclosure and the Sarbanes-Oxley Act have had on firms' ability to MBE, and whether investors react differently to these strategies subsequent to the implementation of these laws.

This study documents that the number of firms that MBE has declined in the early 2000s. Furthermore, the results of the study suggest that the market detects expectations management and applies a discount to firms that use this strategy to MBE. The findings also indicate that prior to Regulation Fair Disclosure, the market is surprised by earnings announcements and reacts differently to the strategies used to MBE. Subsequent to Regulation Fair Disclosure, however, the market is aware of downward expectations management and does not react differently to strategies used to MBE. This study contributes to the literature by using a sample that includes a post Regulation Fair Disclosure and Sarbanes-Oxley Act time period. It also extends the literature by jointly examining the market reaction to two strategies that previously had been examined independently. The results of this study are helpful to standard and policy setters who devise laws to improve financial reporting and investor confidence in the capital markets.