Using Past Earnings as a Benchmark: Does the Market Recognize Abnormal Earnings Growth from Analysts’ Earnings Forecasts?

• In Event: Financial Accounting & Reporting # 1
  In Paper Session: Financial Accounting and Reporting # 1

Abstract

Use of past earnings as a benchmark by managers has been argued in the literature. However its use by the market opens up the possibility of functional fixation especially when a better benchmark can be derived based on the earnings dynamics as characterized in the Abnormal Earnings Growth AEG (Ohlson and Juettner-Nauroth (OJ), 2005). This paper investigates if the market recognizes the forecasts of abnormal growth in earnings, implied in the analysts’ earnings forecasts. The Earnings Dynamics offer another benchmark for future earnings that factor in the wealth effect of past dividends. We investigate the market reaction to the arrival of the first analyst forecast. We develop testable hypotheses based on different scenarios of relative magnitudes of analysts’ forecasts, ED and the past earnings and based on the different possibilities of the sign of the news implied by the choice of alternative benchmarks and examine the market’s reaction to forecast announcement in the different partitions. Introduction of to the hierarchy of benchmarks allows us to partition the data further to characterize good news and bad news with respect to more than one benchmark and see the market’s reaction to consistent good/bad news and mixed news. Our results provide some evidence that the market pays some attention to the earnings dynamics and the wealth effect of past dividends.

Author

• Yin Yu, Oakland University