Kenneth J. Merkley

When Do Firms Initiate Earnings Guidance? The Timing, Consequences, and Characteristics of Firms’ First Earnings Guidance

The decision to provide earnings guidance for the first time is an important disclosure decision that has a significant effect on subsequent earnings guidance decisions. We explore how soon managers initiate earnings guidance after an initial public offering (IPO) and the factors associated with the adoption of this new disclosure policy. Our results suggest that managers in the current environment often initiate public guidance soon after their IPOs. Specifically, we find that more than 31 (59) percent of our sample firms provide earnings guidance within 90 (365) days of going public. We explore factors that are likely related to the supply of and demand for early earnings guidance. We find evidence of a positive association between the timing of earnings guidance initiation and the involvement of influential external parties (analysts, venture capital firms, and private equity firms) and the proportion of industry peers that guide and a negative association between the timing of first guidance and IPO information uncertainty. In addition, we find a positive association between abnormal returns and first guidance forecast news, consistent with investors generally relying on first-time guidance. We also find that firms in short-term focused industries tend to provide shorter-horizon initial guidance. Overall, the results indicate that, while the timing of first guidance varies with firm-specific measures of the costs and benefits of disclosure predicted by theory, the horizon of first guidance depends mostly on industry factors.

Disclosure Timing and the Economic Role of Mandatory Reporting: Evidence from Managers’ Decisions to File Audited Reports Early

We investigate how managers’ decisions to file audited financial reports prior to SEC reporting deadlines relate to the economic role of mandatory reporting. Contrary to the view that audited financial reports will be more informative when they are filed earlier, we find that managers file audited reports early when they have less informative disclosures. It is unlikely that this result is due to managers filing reports early in a manner that impairs their potential to be informative; we find that early reports are more reliable and are similar to on-time reports in terms of year-over-year content revision. We further find that the percentage of information in the report relative to total information is lower for early reports, consistent with the greater preemption of information via other disclosure channels. Our collective evidence suggests that managers’ decisions to file early are more consistent with the confirmation role of reporting instead of the information role, suggesting that on-going regulatory efforts to enhance informativeness via shorter deadlines might not achieve the intended consequences.

Through the Eyes of the Founder: CEO Characteristics and Firms' Regulatory Filings

We examine whether textual attributes of firms’ regulatory filings reflect CEO characteristics and whether investors consider this relation when assessing firm value. We build on prior research that shows founders have unique personality attributes, particularly overoptimism. We find that 10-K text for founder-led firms is characterized by “excess” optimism relative to current and future realized earnings and relative to non-founder-led firms. The effect is mitigated for firms with large auditors, high litigation risk and high analyst following. Based on stock price at the 10-K release, investors do not appear to appropriately discount the tone, resulting in predictable negative returns during the year subsequent to the 10-K release, particularly for the first two years after firms go public. To bolster the conclusion that CEOs influence text, we provide broad sample evidence that CEO fixed effects are significantly related to several textual attributes.

Direct Measures of Auditors' Quantitative Materiality Judgments: Properties, Determinants and Consequences for Audit Characteristics and Financial Reporting Reliability

For a large sample of audits carried out during 2005-2015 by eight large accounting firms and inspected by the PCAOB, we provide evidence on the properties of auditors’ quantitative materiality judgments and the consequences of those judgments for financial reporting. We find that auditors’ quantitative materiality judgments do not appear to result only from applying conventional rules-of-thumb, specifically, 5% of pre-tax income, but instead are associated with qualitative factors suggested by authoritative guidance and with size-related financial statement outcomes (income, revenues and assets); weights placed by auditors on these outcomes vary with client characteristics such as financial performance. Using non-authoritative guidance in audit-firm policy manuals, we construct a materiality measure (materiality looseness) that is comparable across varying client sizes. We find that looser materiality is associated with fewer audit hours and lower audit fees, supporting the construct validity of this measure. We also find that looser materiality judgments are associated with lower amounts of detected errors and a greater incidence of restatements, highlighting the importance of these decisions for financial reporting reliability. This paper was written while Preeti Choudhary was a Senior Economic Research Fellow at the PCAOB. The PCAOB as a matter of policy disclaims responsibility for any private publication or statement by any of its economic research fellows, consultants and employees. The views expressed in this paper are the views of the authors and do not necessarily reflect the views of the Board, individual Board members, or staff of the PCAOB. We thank Michael Gurbutt, Patrick Kastein, Patricia Ledesma, Christian Leuz, Jessica Watts, Keith Wilson, Luigi Zingales, PCAOB staff and seminar participants at the PCAOB, University of Arizona, ESSEC Business School, University of Florida, George Mason University, HEC Paris, and The Center for Audit Quality Research Advisory Board for helpful discussions.

The Genesis of Voluntary Disclosure: An Analysis of Firms’ First Earnings Guidance

The decision to provide earnings guidance for the first time is an important disclosure decision that has a significant effect on subsequent earnings guidance decisions. We explore how soon managers initiate earnings guidance after an initial public offering (IPO) and the factors associated with the adoption of this new disclosure policy. Our results suggest that managers in the current environment often initiate public guidance soon after their IPOs. Specifically, we find that more than 31 (59) percent of our sample firms provide earnings guidance within 90 (365) days of going public. We explore factors that are likely related to the supply of and demand for early earnings guidance. We find evidence of a positive association between the timing of earnings guidance initiation and the involvement of influential external parties (analysts, venture capital firms, and private equity firms) and the proportion of industry peers that guide and a negative association between the timing of first guidance and IPO information uncertainty. In addition, we find a positive association between abnormal returns and first guidance forecast news, consistent with investors generally relying on first-time guidance. We also find that firms in short-term focused industries tend to provide shorter-horizon initial guidance. Overall, the results indicate that, while the timing of first guidance varies with firm-specific measures of the costs and benefits of disclosure predicted by theory, the horizon of first guidance depends mostly on industry factors.

Initiating earnings guidance: Factors related to IPO firms’ first guidance decision

The decision to provide earnings guidance for the first time is an important disclosure decision that has a significant effect on subsequent earnings guidance decisions. We explore how soon managers initiate earnings guidance after an initial public offering (IPO) and the factors associated with the adoption of this new disclosure policy. Our results suggest that managers in the current environment often initiate public guidance soon after their IPOs. Specifically, we find that more than 31 (59) percent of our sample firms provide earnings guidance within 90 (365) days of going public. We explore factors that are likely related to the supply of and demand for early earnings guidance. We find evidence of a positive association between the timing of earnings guidance initiation and the involvement of influential external parties (analysts, venture capital firms, and private equity firms) and the proportion of industry peers that guide and a negative association between the timing of first guidance and IPO information uncertainty. In addition, we find a positive association between abnormal returns and first guidance forecast news, consistent with investors generally relying on first-time guidance. We also find that firms in short-term focused industries tend to provide shorter-horizon initial guidance. Overall, the results indicate that, while the timing of first guidance varies with firm-specific measures of the costs and benefits of disclosure predicted by theory, the horizon of first guidance depends mostly on industry factors.