Investor Response to Bad News versus Good News Management Earnings Guidance

SYNOPSIS: Prior research consistently reports stronger stock price responses to bad news management guidance than to good news guidance. Based on this result, several studies use the direction of guidance as a proxy for its credibility. We propose that managers opportunistically issue some small bad news guidance for the purpose of reducing earnings expectations to beatable levels. We expect investors to view small bad news guidance as less credible than small good news guidance. We find that investors respond less to small bad news guidance than to similar magnitudes of good news guidance. We show that investor skepticism is justified because small bad news guidance is generally less accurate than the prevailing consensus analyst forecast, whereas other guidance is typically more accurate than the prevailing consensus analyst forecast. Furthermore, the likelihood that bad news guidance is less accurate than the prevailing analyst forecast has increased since the mid-1990s.