Jeffery S. Abarbanell

Can Stock Recommendations Predict Earnings Management and Analysts' Earnings Forecast Errors?

In this article we present evidence that a firm’s stock price sensitivity to earnings news, as measured by outstanding stock recommendation, affects its incentives to manage earnings and, in turn, affects analysts’ ex post forecast errors. In particular, we find a tendency for firms rated a Sell (Buy) to engage more (less) frequently in extreme, income-decreasing earnings management, indicating that they have relatively stronger (weaker) incentives to create accounting reserves especially in the form of earnings baths than other firms. In contrast, firms rated a Buy (Sell) are more (less) likely to engage in earnings management that leaves reported earnings equal to or slightly higher than analysts’ forecasts. Our empirical results provide direct evidence of purported, but heretofore, weakly documented equity market incentives for firms to manage earnings. They are also consistent with a growing body of literature that finds analysts either cannot anticipate or are not motivated to anticipate completely in their forecasts firms’ efforts to manage earnings. ∗University of North Carolina;†University of Michigan. Special thanks to Robert Bushman and Raffi Indjejikian for many useful discussions and comments. We also appreciate the comments of Fran Ayers, Sudhakar Balachandran, Mary Barth, Sudipta Basu, Bill Beaver, Peggy Bishop, John Core, Tom Dykman, John Jacobs, Rick Lambert, Bill Lanen, Carolyn Levine, Chris Noe, Maria Nondorf, Pat O’Brien, Krisna Palepu, Christine Petrovits, Cathy Schrand, Abbie Smith (editor), Brett Trueman, Jim Wahlen, Beverly Walther, two reviewers, and seminar participants at Columbia University, Cornell University, Harvard University, the London Business School, Rice University, Stanford University, Tel Aviv University, the University of California–Berkeley, the University of Chicago, the University of North Carolina, the University of Oklahoma, the University of Pennsylvania, the University of Utah, the University of Waterloo, Mellon Capital Management, Barclays Global Investors, the First Annual Utah Winter Accounting Conference, and the 2001 Financial Management Association Paris meetings.

The Effects of Institutional Investor Preferences on Ownership Changes and Stock Prices around Corporate Spin-offs

Because spin-offs create new firms with characteristics markedly different from the original firm, institutional investors pre-committed to certain investment styles and/or subject to fiduciary restrictions have incentives to rebalance their portfolios at the time of the spin-off. Prior articles in the business press and academic journals claim that the large volume of trading related to this rebalancing creates short-term price pressure in stocks of the entities emerging from the spin-off. In this paper, we examine whether corporate spin-offs lead to significant changes in the holdings of institutional investors and whether these changes do create temporary price pressure. We find strong evidence that investment strategy and fiduciary restrictions affect institutional investor demand for the stocks after spin-offs. However, our results indicate that matching of institutional buying and selling is sufficiently complete in most cases to allow for large volumes of shares to change hands without prices deviating from fundamentals.

Do Bright-Line Earnings Surprises Really Affect Stock Price Reactions?

Several influential studies have concluded that earnings surprises just to the right or to the left of a hypothesized bright line produce distinct price reactions compared with surrounding earnings surprises because they convey special meaning. In this study, we examine whether previous inferences of asymmetric stock price reactions to bright-line surprises are observed when empirical tests are designed to be consistent with a rational expectations equilibrium. Focusing on a small range of earnings surprises around hypothesized bright lines, we find no evidence of asymmetric price reactions once investors’ ex ante expectation of bias in earnings surprises is controlled. Results from additional tests yield support for the external validity of the theoretical framework underlying our bright-line pricing tests. Our findings suggest simple refinements to traditional bins-comparison and regression tests for asymmetric price reactions to bright-line earnings surprises, which account for necessary conditions imp...