Liem Nguyen Westfield State University Judy K. Beckman and Henry Oppenheimer

1. Mimicking and Herding Behaviors among U.S. Investment Analysts: Implications for Market Reactions to Actual Earnings Announcements Liem Nguyen Westfield State University Judy K. Beckman and Henry Oppenheimer University of Rhode Island • AAA Atlanta Annual Meetings August 6, 2014

2. Introduction CVS Management Analysts Institutional Investors, Regulators, Credit Rating Agencies, Suppliers, etc. Introduction Background

3. Management Voluntary Disclosure • “CVS Caremark (CVS) issued weak 2011 earnings guidance, and its shares fell 6% in morning trading. CVS posted fourth quarter earnings of 80 cents, versus expectations for 81cents” Barron’s February 3, 2011 • Tyco (TYC) now expects earnings of 30 cents to 33 cents a share instead of the 45 cents to 47 cents guidance it gave in July, chief executive Ed Breen said in his first conference call with the company's investors.” AP September 2005. Introduction Background

4. Introduction The Sequence of Management Annual Earnings Guidance and Analyst’s Estimates Herding occurs when the subsequent analysts issue forecasts within 1 cent of the first Management Announces Annual Earnings Guidance Actual Annual Earnings Is Released (ACT) (GUI) $3.50 $3.45 $3.40 $3.42 $3.40 Analyst’s Consensus Number (PRIOR) Last Analyst’s Consensus Number (LAST) First Analyst’s Consensus Number (FIRST) Mimicking occurs when the amount is within 1 cent of management guidance

5. Literature: Meetable/Beatable Forecasts (Mimicking) • Skinner (1994) • Managers may preempt announcement of negative earnings surprises to reduce the potential costs of shareholder suits • Soffer et al. (2000) • - short-term management earnings guidance tends to be downwardly biased • Matsumoto (2002) and Richardson, Teoh, and Wysocki (2004) • - firms “walk” analysts toward beatable earnings forecasts via their earnings guidance disclosures Literature

6. Literature: Management Incentives • Baikand Jiang (2006) • Management dampens analysts’ earnings expectations with pessimistic quarterly guidance when their firms: • Have high growth opportunities, • operate in a high-litigation industry, • have transient institutional ownership. • All factors above are associated with pessimistic management guidance because of the costs of missing the consensus of analysts forecasts. Literature

7. Literature: Herding Behaviors • Trueman (1994) - Math models predict that an analyst prefers to release an earnings forecast that is close to prior earnings expectations even when his/her own information justifies a more extreme forecast. • Hong, Kubik, and Solomon (2000) - find that more experienced analysts are more likely to issue bold forecasts than are less experienced analysts and that brokerage firms are more likely to discharge the less experienced analysts for inaccurate or bold forecasts Literature

8. Literature: Herding Behaviors • Clement and Tse (2003, 2005) • - find that analyst characteristics are associated with forecast accuracy for both bold and herding forecasts • Gleason and Lee (2003) • - bold forecast revisions generate stronger return responses than do herding forecast revisions Literature

9. Literature: Herding Behaviors and Extreme Earnings Surprises Trueman (1994, p. 98) When herding is observed among analysts: Extreme surprise announcements of actual earnings => smaller stock price reactions than would be expected from analysts using information in an an unbiased manner to produce their forecasts. Reasoning: Investors recognize the possibility that an analyst actually had information that justified a more extreme forecast. Consequently, large earnings “surprises” do not surprise investors as much as if they had taken the announced forecast at face value.

10. Literature: Influence of Regulation FD • Findlay and Mathew (2006) • After implementation in October 2000 of US. SEC Regulation Fair Disclosure (Reg. FD), analyst forecast accuracy declines overall, but analysts that were less accurate (more accurate) before Reg. FD improve (become less accurate) after its implementation • Bailey, Li, Mao, and Zhong (2003) • find that after the passage of Regulation FD, analyst forecast dispersion increases Literature

11. Research Motivation • How do analysts revise their estimates conditional on management earnings guidance releases? • How do following analysts revise their estimates when faster analysts revise their estimates following management earnings guidance? • Does Regulation Fair Disclosure change the way analysts revise their estimates? • Do analyst herding behaviors result in market reactions to actual earnings announcements as predicted by Trueman (1994)? Introduction Research Motivation

12. Data and Methodology • First Call (1995 – 2009) • Annual earnings per share (EPS) management guidance • Omit guidance events that occur after the fiscal year end but before the earnings announcement • Mid-point of the earnings guidance if given as a range • Omit observations without CUSIP • Neutral/Negative/Positive Surprises: the guidance qualifies as a positive (negative) surprise when it is higher (lower) than the current expectationbased on the last analyst’s consensus update prior to the guidance • Examine analysts forecast revisions issued within 7 days of management guidance Data and Methodology

13. Table 1 – Comparison of Management Guidance Events for Annual v. Quarterly Earnings

14. Measuring Mimicking and Herding The Sequence of Management Annual Earnings Guidance and Analyst’s Estimates Herding occurs when the subsequent analysts issue forecasts within 1 cent of the first Management Announces Annual Earnings Guidance Actual Annual Earnings Is Released (ACT) (GUI) $3.50 $3.40 $3.39 $3.42 $3.40 $3.38 Analyst’s Consensus Number (PRIOR) Last Analyst’s Consensus Number (LAST) First Analyst’s Consensus Number (FIRST) Mimicking occurs when the amount is within 1 cent of management guidance

15. Clement and Tse (2005, JF) and Gleason and Lee (2003, TAR) Measurement

16. Hypotheses Related to Mimicking • H1-1: Analysts are less likely to mimic management’s earnings guidance for firms which ultimately experience losses than for other firms. • H1-2: Analysts are less likely to mimic management’s earnings forecasts when following firms with higher potential litigation costs than for firms without this potential. • H1-3: Analysts are less likely to mimic management’s earnings guidance for growth firms than for other firms. • H1-4: Analysts are less likely to mimic management’s earnings guidance after the implementation of Regulation Fair Disclosure than they were before the implementation. Hypotheses

17. Hypotheses Related to Herding • H2-1: Following analysts are less likely to herd if the first analyst mimics management’s earnings guidance. • H2-2, 3, and 4: Analysts are less likely to herd together for • -2 loss firms, -3 high litigation firms, -4 growth firms • H2-5: Analysts are more likely to herd after the implementation of Regulation Fair Disclosure than before. Hypotheses

18. Hypothesis Related to Herding and Market Reaction to Earnings Announcements H3: Under extreme surprise outcomes from actual earnings announcements, the overall market reaction is less intense if analysts previously herded their forecasts following the management earnings guidance than it is when herding was not observed among analysts in response to management earnings guidance.

19. Empirical Results Analyst’s revision dates after the release of Management Earnings Guidance (1995-2009) Empirical Results

20. Empirical Results Figure 3A: Earnings difference between analyst’s estimates and management earnings guidance (1995-2009) Empirical Results

21. Empirical Results Figure 3B: Earnings difference between management earnings guidance and actual earnings (1995-2009) Empirical Results

22. Descriptive Statistics (n = 67,595)

23. Logitregression of analysts’ mimicking reaction to management annual earnings guidance (1995-2009) Empirical Results

24. Table 6 - Logit regression of following analysts’ herding reaction to first analyst’s estimates after management annual earnings guidance (1995-2009) Empirical Results

25. Empirical Results Model 3 - Linear regression of market reactions to actual earnings announcement for extreme earnings surprise of 10% or more (1995-2009) Empirical Results

26. Table 7 - Linear regression of market reactions to actual earnings announcement for extreme earnings surprise (1995-2009) Empirical Results

27. Conclusion • Analysts are less likely to mimic their estimates • higher litigation potential firms • growth firms • loss firms • After Regulation FD • Analysts are less likely to herd their estimates • When the first analyst mimics • Before Regulation FD • Confirmation of Trueman (1994) theory: Market reacts less intensively to actual earnings announcements of extreme (top and bottom 10%) surprises after observing analysts’ prior herding behavior.