This study examines whether Australian management earnings forecasts provide additional information to current market expectations (proxied by consensus analysts' forecasts). This issue is important because management earnings forecasts should be a valuable source of information for the investment community, and the Continuous Disclosure Regime introduced in September 1994 requires firms to make timely disclosures of material price sensitive information. This study classifies management earnings forecasts into informative forecasts that correct current analysts' forecasts and less informative forecasts that confirm current analysts' forecasts. It is hypothesized that managers tend to issue confirmatory forecasts for positive earnings news to create a good public image of being open with the financial market and to maintain a cooperative relationship with financial analysts. Conversely, management is expected to issue correctional forecasts for negative earnings news to reduce potential legal liability costs and reputation costs. As bad news forecasts are expected to be associated with correctional forecasts that have more information content than confirmatory forecasts, investor reaction to bad news is expected to be greater than investor reaction to good news.
The results of this study support these hypotheses. Evidence shows that managers are most likely to issue good news confirmatory forecasts, followed by bad news correctional forecasts. Consistent with this observation, it is found that bad news forecasts precede larger actual earnings surprises than good news forecasts, and that investor reaction is greater for bad news forecasts than for good news forecasts. This study contributes to the literature by extending the expectations adjustment hypothesis to explain two puzzling issues: (1) why managers issue forecasts with little information content, and (2) why investors react more strongly to bad news than to good news. The results provide support for the theory developed in this study. Further, the finding that managers rarely forecast large positive earnings surprises suggests non-compliance with the Continuous Disclosure Regime and adds to the evidence regarding the ineffectiveness of the Continuous Disclosure Requirements.