Just Say No to Wall Street: Putting a Stop to the Earnings Game

Abstract

CEOs and CFOs put themselves in a bind by providing earnings guidance and then making decisions designed to meet Wall Street's expectations for quarterly earnings. When earnings appear to be coming in short of projections, top managers often react by suggesting or demanding that middle and lower level managers redo their forecasts, plans, and budgets. In some cases, top executives simply acquiesce to increasingly unrealistic analyst forecasts and adopt them as the basis for setting organizational goals and developing internal budgets. But in cases where external expectations are impossible to meet, either approach sets up the firm and its managers for failure. Copyright Copyright (c) 2010 Morgan Stanley.

The financial reporting environment: Review of the recent literature

“…However, based on a survey of 654 members of the National Investor Relations Institute (NIRI), Hirst et al (2008) document that as of 2006, the percentage of publicly traded companies providing annual guidance increased from 61% to 82% while the percentage of companies providing quarterly guidance declined from 61% to 52%. Hirst et al (2008) explain that this change in behavior may be the result of market participants (CFA Institute, 2006) and numerous researchers (e.g., Fuller and Jensen, 2002) expressing concerns over managers using their earnings forecasts to strategically manage the analysts' consensus earnings forecasts. In particular, Fuller and Jensen (2002) claim that this type of managerial and analyst behavior represents a game, particularly when it is done on a quarterly basis.…”

“…Hirst et al (2008) explain that this change in behavior may be the result of market participants (CFA Institute, 2006) and numerous researchers (e.g., Fuller and Jensen, 2002) expressing concerns over managers using their earnings forecasts to strategically manage the analysts' consensus earnings forecasts. In particular, Fuller and Jensen (2002) claim that this type of managerial and analyst behavior represents a game, particularly when it is done on a quarterly basis. Based on this, Fuller and Jensen (2002) call for firms to stop providing any quarterly earnings guidance.…”

What is Ethical About Grade Inflation and Coursework Deflation?

“…Executives caught engaging in abusive earnings management are fined and even sent to prison (Fuller and Jensen 2010). A new profession of forensic accountants is growing to catch these unethical executives and fraudsters.…”

“…Sometimes the dividing line depends upon the over-all facts or materiality. Fuller and Jensen (2010) provide an excellent description of the earnings management process:…”

Investor relations: a comprehensive overview

“…For more information about the issue, please see e.g.,Collingwood (2001);Fuller and Jensen (2002);Bartov et al (2002);Hirst et al (2008). See alsoChan et al (2007) for analysts' conflicts of interest and biases in earnings forecasts.…”