2017- Working Papers: Finance, Accounting and Insurance

This paper analyzes a manager's optimal expectations management strategy in a setting in which the manager provides forecast guidance to an analyst both privately and publicly. Conventional wisdom suggests that managers use private communications with analysts and public earnings forecasts interchangeably to guide analysts' earnings forecasts downward toward lower earnings targets. Our analysis shows that in markets with rational investors, private and public guidance play very different roles in managing expectations and that managers benefit from downward guidance only in their private communication with analysts. In their public forecasts they benefit from introducing an upward bias. We explore how the effectiveness of the private and public channels in communicating information to analysts affects managers' incentive to engage in expectations management and provide a number of empirical predictions. Among other results, we show how reducing private communication between managers and analysts (through means such as Regulation Fair Disclosure) can increase price efficiency, weaken managers' motivation to engage in private, as well as public, expectations management, and increase managers' motivation to provide public disclosures.

Our analysis is rooted in the notion that stockholders can learn about the fundamental value of any particular firm from observing the earnings reports of its rivals. We argue that such intra-industry information transfers, which have been broadly documented in the empirical literature, may motivate managers to alter stockholders’ beliefs about the value of their firm not only by manipulating their own earnings report but also by influencing the earnings reports of rival firms. Managers obviously do not have access to the accounting system of peer firms, but they can nevertheless influence the earnings reports of rival firms by distorting real transactions that relate to the product market competition. We demonstrate such managerial behavior, which we refer to as cross-firm real earnings management, and explore its potential consequences and its interrelation with the practice of accounting-based earnings management within an industry setting with imperfect (non-proprietary) accounting information.

Firms should disclose information on material cyber-attacks. However, because managers have incentives to withhold negative information, and investors cannot independently discover most cyber-attacks, firms may underreport cyber-attacks. Using data on cyber-attacks that were voluntarily disclosed by firms and those that were withheld and later discovered by sources outside the firm, we estimate the extent to which firms withhold information on cyber-attacks. We find withheld cyber-attacks are associated with a decline of approximately 3.6% in equity values in the month the attack is discovered, and disclosed attacks, with a substantially lower decline of 0.7%. The evidence is consistent with managers not disclosing negative information below a certain threshold, and withholding information on the more severe attacks. Using the market reactions to withheld and disclosed attacks, we estimate that managers disclose information on cyber-attacks when investors already suspect a high likelihood (40%) that an attack has occurred. Overall, our analyses suggest firms underreport cyber-attacks.