The Markets Reaction to Bias in Management Earnings Forecasts and Subsequent Return Reversals

Abstract

This study examines whether the market reacts to the bias included in management earnings forecasts(MEF) at

the time of the MEF announcement and reverse that reaction at the time of subsequent earnings announcement.

In our analyses, we assume that management earnings forecasts contain an unbiased information component and

a bias component. If investors are unable to differentiate between these two components and naively respond to

the bias component in the MEF, then we expect to observe a subsequent return reversal when actual earnings are

announced.

Our empirical results are as summarized as follows: (1) investors initially respond to the bias component in MEF

but the magnitude of that response is smaller than the magnitude of the response to the unbiased information

component. (2) we find the statistical significant evidence of return reversal occurring when earnings are

subsequently reported. (3) the naive response of investors to the bias component in MEF is restricted to only longterm

forecasts. The magnitude of the stock price response to the bias in short-term forecasts is not significantly

different from zero