To Guide or Not to Guide - Causes and Consequences of Stopping Quarterly Earnings Guidance by Joel F. Houston, Baruch Lev and Jennifer W. Tucker

Electronic copy available at: http://ssrn.com/abstract=875184

To Guide or Not to Guide?Causes and Consequences of Stopping Quarterly Earnings GuidanceJoel F. HoustonDepartment of FinanceUniversity of Florida(352) 392-7546Joel.houston@cba.ufl.eduBaruch LevDepartment of Accounting New York University(212) 998-0028 blev@stern.nyu.eduJennifer W. Tucker Fisher School of AccountingUniversity of Florida(352)273-0214Jenny.tucker@cba.ufl.eduMay 2008

We thank Bipin Ajinkya, Ted Christensen, Jay Ritter, and participants of the University of Florida accounting workshop, the 2006 AAA Annual Conference, and seminars at the FederalReserve Bank of Philadelphia, the 2006 Conference at the University of Washington in St.Louis, and Nanyang Technological University in Singapore for helpful comments, and LiangFu, Carlos Jimenez, Richard Lu, and Jason MacGregor for research assistance.

Electronic copy available at: http://ssrn.com/abstract=875184

To Guide or Not to Guide?Causes and Consequences of Stopping Quarterly Earnings Guidance

ABSTRACT

In recent years, quarterly earnings guidance has been harshly criticized for inducing“managerial short-termism” and other ills. Managers are, therefore, urged by influentialinstitutions to cease guidance. We examine empirically the causes of such guidance cessationand find that poor operating performance—decreased earnings, missing analyst forecasts, andlower anticipated profitability—is the major reason firms stop quarterly guidance. After guidance cessation, we do not find an appreciable increase in long-term investment oncemanagers free themselves from investors’ myopia. Contrary to the claim that firms would provide more alternative, forward-looking disclosures in lieu of the guidance, we find thatsuch disclosures are curtailed. We also find a deterioration in the information environment of guidance stoppers in the form of increased analyst forecast errors and forecast dispersion anda decrease in analyst coverage. Taken together, our evidence indicates that guidance stoppersare primarily troubled firms and stopping guidance does not benefit either the stoppers or their investors.Keywords: earnings guidance, voluntary disclosure, managerial myopia, guidance cessation.

Electronic copy available at: http://ssrn.com/abstract=875184

To Guide or Not to Guide?Causes and Consequences of Stopping Quarterly Earnings Guidance

The law of large numbers has caught up with Dell. Once worshipped for consistent performance, Dell has had seven quarters of declining revenue growth and missed itsown revenue predictions in three of the last four quarters. It finally gave up giving quarterly guidance (arguing that its competitors don’t do so either).

(

Forbes

, June 19,2006, p. 44).

1. Introduction

Quarterly earnings guidance—managers’ public forecasts of forthcoming earnings—iswidespread yet highly controversial. A recent position paper by the CFA Institute and theBusiness Roundtable emphatically calls on managers to “end the practice of providing quarterlyearnings guidance” (CFA 2006, p.2). Similarly, the U.S. Chamber of Commerce (2007) publiclyimplored managers to stop providing quarterly guidance. Arguments for ending the practice of guidance are made by purists, who claim that managers should tend to their business and leavesecurities valuation and the underlying forecasts of future performance to investors and analysts,and by pragmatists, lawyers in particular, who caution managers that guidance increaseslitigation exposure. Regulators and commentators are often concerned that a previously issuedforecast will motivate managers to meet the guidance even if doing so would require costlychanges in real activities, such as cutting capital expenditures or R&D, and sometimes inducethem to manage earnings toward the forecast (Levitt 2000). And then there is the frequentlyvoiced view that issuing quarterly guidance caters to the whims of short-term (myopic) investors,driving managers to accommodate these investors by engaging in myopic behavior that sacrificesthe company’s long-term growth. All in all, concludes the consulting company McKinsey,quarterly earnings guidance is “misguided” (Hsieh et al. 2006). The anti-guidance arguments areserious indeed.1