Lawrence D. Brown
Georgia State University
Huong N. Higgins
Worcester Polytechnic Institute
Abstract: Corporate insiders have incentives to manipulate short-term stock prices by creating positive earnings surprises (Levitt 1998). They have two ways to do this: (1) manage reported earnings upwards or (2) guide analyst forecasts downwards (Matsumoto 2002). Recent studies show that stronger governance suppresses insiders management of reported earnings (Bhattacharya et al. 2002; Leuz et al. 2002), suggesting that stronger governance likely mitigates management of earnings surprises. However, strong governance causes rational insiders to substitute analyst forecast guidance for management of reported earnings so it may not mitigate management of earnings surprises. The extant literature has provided no evidence of the impact of governance mechanisms either on insiders guidance of analysts or on insiders management of earnings surprises. Using data from 21 countries, we show that managers of firms facing stronger governance are relatively more likely to guide analysts forecasts downwards, less likely to manage reported earnings, and more likely to create positive earnings surprises.
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