The Market reaction to Earnings Thresholds
The research I propose to conduct is an extension of Degeorge, Patel and Zeckhauser´s piece "Earnings management to exceed thresholds" (Journal of Business, January 1999). Our previous article argued that for behavioral and incentive reasons, company executives manage reported earnings in order to exceed certain thresholds. We found empirical support for this conjecture in a large sample of U.S. firms over the 1974-1996 period. Company executives seek to (1) report profits, (2) sustain recent performance, and (3) meet analysts´ expectations. Moreover, we found that companies barely meeting an earnings threshold exhibit disappointing accounting performance thereafter.Our study focused on earnings management and only looked at accounting data. A natural extension of our work is to consider its security pricing implications: does the stock market consider earnings thresholds an important signal?
We plan to examine two questions: (1) what is the immediate market reaction to a company´s meeting (or missing) an earnings threshold? (2) is the future disappointing accounting performance documented by us correctly impounded in the immediate reaction -that is, do we observe drifts in the stock returns of companies that barely met a threshold?