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An International Meeting of American Accounting
Association
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Do Managers Talk Down Overvaluation? |
Kevin C.W. Chen
Hong Kong University of Science & Technology
Kai Wai Hui
Hong Kong University of Science & Technology
K.C. John Wei
Hong Kong University of Science and Technology
Abstract: In this paper, we test Jensen’s (2005) hypotheses related to the agency cost of overvalued equity using management forecasts that result in analysts’ downward revision of earnings forecasts (referred to as “bad news forecasts” hereafter). Using data from 1997-2002, we find that bad news forecasts are effective in speeding up the correction of overvaluation. Further, managers have more incentives to issue a bad news forecast when their company is more overvalued, where the incentives are measured by the frequency, the speed, and the extent to which managers bring down earnings expectations. In addition, we show that when a firm is overvalued, litigation risk and corporate governance systems increase managers’ incentives to talk down earnings expectations, while equity-based compensation and short selling activities reduce the incentives. However, when a firm’s equity is relatively less or not overvalued, managers’ incentives to issue a bad news forecast are not related to these factors.