Sanjeev Bhojraj

The Association between Outside Directors, Institutional Investors and the Properties of Management Earnings Forecasts

We investigate the relation of the board of directors and institutional ownership with the properties of management earnings forecasts. We find that firms with more outside directors and greater institutional ownership are more likely to issue a forecast and are inclined to forecast more frequently. In addition, these forecasts tend to be more specific, accurate and less optimistically biased. These results are robust to changes specification, Granger causality tests, and simultaneous equation analyses. The results are similar in the pre- and post-Regulation Fair Disclosure (Reg FD) eras. Additional analysis suggests that concentrated institutional ownership is negatively associated with forecast properties. This association is less negative in the post-Reg FD environment, which is consistent with Reg FD reducing the ability of firms to privately communicate information to select audiences. Copyright 2005 The Institute of Professional Accounting, University of Chicago.

Making Sense of Cents: An Examination of Firms that Marginally Miss or Beat Analyst Forecasts

This paper examines the performance consequences of cutting discretionary expenditures and managing accruals to exceed analyst forecasts. We show that firms that just beat analyst forecasts with low quality earnings exhibit a short-term stock price benefit relative to firms that miss forecasts with high quality earnings. This trend, however, reverses over a 3-year horizon. Additionally, firms reducing discretionary expenditures to beat forecasts have significantly greater equity issuances and insider selling in the following year, consistent with managers understanding the myopic nature of their actions. Our results confirm survey evidence suggesting managers engage in myopic behavior to beat benchmarks. THERE IS GROWING EVIDENCE that managers are willing to sacrifice economic value to meet short-run earnings objectives. For example, Graham, Harvey, and Rajagopal (2005) report that a majority of managers would forgo a project with positive net present value (NPV) if the project would cause them to fall short of the current quarter consensus forecast. When asked what actions they might take in order to meet an earnings target, approximately 80% suggest they would decrease discretionary spending, including R&D and advertising expense. This survey evidence is consistent with other research on myopic behavior and real earnings management (e.g., Baber, Fairfield, and Haggard (1991), Bhojraj and Libby (2005), Roychowdhury (2006)). Jensen (2005) attributes this behavior in part to the agency costs of overvalued equity, noting that “when numbers are manipulated to tell the market what they want to hear . . . and when real operating decisions that would maximize value are compromised to meet market expectations, real long-term value is being destroyed” (p. 8). In this paper, we provide evidence on the shortand long-term price and profitability ∗Sanjeev Bhojraj is from the Johnson School of Management, Cornell University. Paul Hribar is from the Tippie College of Business, University of Iowa. Marc Picconi is from the Kelley School of Business, Indiana University. John McInnis is from the McCombs School of Business, University of Texas at Austin. The authors gratefully acknowledge the insightful comments and suggestions made by Cam Harvey (the editor), an associate editor, and an anonymous referee, as well as seminar participants at Cornell University, Columbia University, Duke University, the University of Illinois, the University of Minnesota, the University of North Carolina, the University of Oklahoma, the University of Rochester, and Washington University in St. Louis. The authors thank Thomson Financial Services Inc. for providing earnings per share forecast data, available through the Institutional Brokers Estimate System (I/B/E/S). These data have been provided as part of a broad academic program to encourage earnings expectation research.

Who Is My Peer? A Valuation‐Based Approach to the Selection of Comparable Firms

This study presents a general approach for selecting comparable firms in market‐based research and equity valuation. Guided by valuation theory, we develop a “warranted multiple” for each firm, and identify peer firms as those having the closest warranted multiple. We test this approach by examining the efficacy of the selected comparable firms in predicting future (one‐ to three‐year‐ahead) enterprise‐value‐to‐sales and price‐to‐book ratios. Our tests encompass the general universe of stocks as well as a sub‐population of so‐called “new economy” stocks. We conclude that comparable firms selected in this manner offer sharp improvements over comparable firms selected on the basis of other techniques.

Macromomentum: Returns Predictability in International Equity Indices

This study examines momentum and reversals in international stock market indices. We find that country stock indices exhibit momentum during the first year after the portfolio formation date and reversals during the subsequent 2 years. Positive currency momentum predicts low stock index returns in the future, thereby weakening momentum and strengthening reversals in U.S. dollar-denominated stock index returns. Cross-sectional regression tests involving individual stock indices confirm the portfolio findings. Our results are consistent with a key prediction of recent behavioral theories, that initial momentum should be accompanied by subsequent reversals.

Margin Trading, Overpricing, and Synchronization Risk

We provide experimental evidence that relaxing margin restrictions to allow more short selling can exacerbate overpricing, even though it reduces equilibrium price levels. This is because smart-money traders initially profit more by front-running optimistic investor sentiment than by disciplining prices. When short selling is not possible, competitive pressures among arbitrageurs rapidly drive prices to the equilibrium. However, the risk of margin calls slows the convergence process, because arbitrageurs who sell short too early face substantial losses if they are unable to synchronize their trades with other arbitrageurs (as in Abreu and Brunnermeier. 2002. Journal of Financial Economics 66(2--3):341--60; 2003. Econometrica 71(1):173--204). The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

Macromomentum: Evidence of Predictability in International Equity Markets

This study examines momentum and reversals in portfolios of international stock indices. The results indicate strong momentum up to a year following the portfolio formation date and significant reversals in the subsequent two years. While momentum is driven mostly by predictability within equity markets, reversals are at least partly due to a continuing decline in stock prices in response to past currency appreciation. These patterns seem to be related to misreaction to news about macroeconomic conditions, not corporate earnings. Overall, our results demonstrate the pervasiveness of momentum and reversals and provide support for behavioral theories.

Restructuring Charges, FAS 146, and the Accrual Anomaly

In this study, we examine the role of restructuring charges in the existence and subsequent weakening of the widely documented accrual anomaly. We find that prior to 2003 the significant positive abnormal hedge returns experienced by accrual based strategies were influenced by a subset of firms with high restructuring charges. After 2003, with the introduction of the Statement of Financial Accounting Standards No. 146 changing the accounting for restructuring charges, restructuring firms no longer experience significant abnormal returns thereby weakening the accrual anomaly. Our results suggest that the regulatory changes have had an effect on impairing the role of restructuring charges in the accrual anomaly by improving the markets ability to correctly assess the valuation implications of restructuring charges in the low accruals portfolios.

Guidance Frequency and Guidance Properties: The Effect of Reputation-Building and Learning-by-Doing

Different firms issue earnings guidance at dramatically different rates. We suggest that frequent guiders more likely represent a type of firm that is attempting to develop a reputation for enhanced disclosures through their guidance issuances. Furthermore, the desire to build a reputation and the opportunities to learn provided by issuing more frequent guidance should translate into frequent guiders providing higher quality guidance than occasional guiders. We examine our hypotheses in three stages. First, we find that guidance frequency is positively correlated with variables associated with reputation with capital market participants and reputation in product and labor markets. Second, our cross-sectional analysis shows that frequent guiders provide guidance that is more accurate and specific, timelier, and less optimistically biased. Third, controlling for overall time trends, we find that firms display improvements over time in their guidance properties. Overall, our results are consistent with the reputation-building and learning-by-doing arguments.

Warranted Multiples and Future Returns

We propose an alternative way of using accounting multiples to predict future returns. We define excess multiple as the difference between an accounting multiple and the warranted multiple based on a firms fundamental value drivers. Firms with low excess multiples have higher one-to-three years ahead stock returns than firms that have high excess multiples. This difference in returns is economically and statistically significant and cannot be explained by Fama-French three factors or a momentum factor.