Management earnings forecasts and adverse selection cost: good vs bad news forecast

Abstract

PurposeThe aim of this paper is to investigate the effect of management earnings forecasts on the level of information asymmetry around subsequent earnings announcement.Design/methodology/approachEmploying the adverse selection cost method suggested by George et al., the paper compares for each sample firm the adverse selection cost around earnings announcement in forecasting years with that in non‐forecasting years.FindingsConsistent with Diamond and Verrecchia is the finding that the earnings announcement in non‐forecasting years decreases information asymmetry during a three‐day announcement period and increases in a post‐announcement period up to seven days. No significant change in information asymmetry between pre‐ and post‐announcement periods when firms released a “good” news forecast is found. The firms that previously released a “bad” news forecast experience a significantly lower information asymmetry than those that did not forecast during announcement or post‐announcement days, and experience a decrease in information asymmetry in a five to seven‐day post‐announcement period.Originality/valueThis paper provides the first empirical reports on the different information asymmetry changes around earnings announcements followed by a “good” news management forecast from those followed by a “bad” news forecast.