Consistent expectation management patterns and market reactions to earnings announcements

This study examines how market participants react to the expectation management behavior of firms, especially when the firms demonstrate consistent patterns of expectation management. Expectation management generally refers to cases where managers provide pessimistic earnings guidance to analysts, followed by a positive earnings surprise at the earnings announcement. I propose that the market will reward firms that manage expectations successfully because of those firms' higher management expertise, conservative voluntary disclosure policy and lower ex ante probability of beating/meeting earnings expectations.;Using management guidance data to identify expectation management firm-quarters, I find, as predicted, that after controlling for self-selection bias, the market rewards firms that manage earnings expectations successfully. I also find that there is an incremental reward to firms that consistently manage earnings expectations. This indicates that the more frequent a firm successfully manages earnings expectations, the more favorable the market reaction to its earnings announcements. Furthermore, the reward cannot be explained by the firm's consistently beating/meeting earnings alone. The results show that, conditional on beating the earnings target, the market reward to consistent expectation management firms is higher than the reward to the corresponding non-expectation management firms. This suggests that previously documented market rewards to beating/meeting earnings targets may be at least partially driven by the firms that successfully manage expectations. In addition, I find, compared to non-expectation management firms, expectation management firms do have higher management expertise, are under higher market pressure to deliver beating/meeting earnings target result, have higher litigation risk and more complex business, and tend to be smaller firms with lower Market-to-Book ratio.