To what extent does the audit committee curb downward earnings forecast guidance?
Abstract
Purpose
The purpose of this paper is to examine the association between audit committee characteristics and a firm’s ability to guide analysts’ forecasts downward to meet or beat earnings benchmarks.
Design/methodology/approach
The authors expect that a more effective audit committee would be able to reduce managers’ propensity to use downward forecast guidance to avoid negative earnings surprises. Four committee characteristics are used to measure its effectiveness: independence, diligence, expertise and size.
Findings
For the pre-SOX (Sarbanes-Oxley Act) period (1996-2002), none of the four audit committee characteristics are significantly associated with managers’ propensity to use downward forecast guidance to avoid negative earnings surprises. For the post-SOX era (2003-2004), however, the likelihood of engaging in downward forecast guidance is significantly lower for firms with larger and more independent audit committees. In addition, the likelihood is significantly lower for audit committees that are more diligent and have a higher proportion of the committee members with accounting or finance-related expertise.
Research limitations/implications
Overall, the authors results suggest that, in response to the increased regulatory and listing requirements in the post-SOX era, audit committees have played a more active role in scrutinizing earnings guidance. Our results also suggest that a more effective audit committee in the post-SOX era curbs managers’ tendency to use downward forecast guidance to meet or beat quarterly earnings targets.
Originality/value
To the authors knowledge, this study is one of the first to examine the role of the audit committee in reviewing managerial earnings guidance. As earnings guidance plays an important role in the overall financial reporting process over time and given the increasing importance of downward forecast guidance in earnings surprise games in recent years, the authors believe this study addresses an important question and adds to prior literature. Also, this study contributes to their understanding of the changing nature and scope of audit committee oversight activities since the passage of SOX.
Keywords
Acknowledgements
The authors appreciate the valuable comments provided by the seminar participants at National Taiwan University, National Chengchi University, Tamkung University, The University of Texas at Arlington and 2008 American Accounting Association Annual Meeting. The authors also gratefully acknowledge Thomson Financial for providing earnings per share forecast data, available through the Institutional Brokers Estimate System (I/B/E/S) as part of a broad academic program to encourage earnings expectation research.
Citation
Jennifer Ho, L.-C., Liu, C.-S. and Frank Wang, X. (2014), "To what extent does the audit committee curb downward earnings forecast guidance?", Review of Accounting and Finance, Vol. 13 No. 2, pp. 110-133. https://doi.org/10.1108/RAF-03-2013-0040
Publisher
:Emerald Group Publishing Limited
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