Whether a firm meets or beats analyst forecasts in earnings announcement is commonly viewed as a signal for the firm’s future prospect by the investors. Indeed, the existing research shows that future earnings are higher for those firms that meet or beat analyst forecasts than those firms that miss analyst forecasts. Further, the investors, on average, tend to react positively to firms that meet or beat analyst forecasts and negatively to firms that fall short of analyst forecasts. Specifically, the investors punish a firm that falls short of analyst forecasts at a higher magnitude than rewards a firm that meets or beats analyst forecasts. That is, the investors asymmetrically react to beating and missing analyst forecasts and this asymmetric market reaction is more pronounced for growth firms because the investors set a higher expectation on those firms.

Given the fact that managers’ compensation, value of stock options, and job security are tied to stock prices in which firms’ meeting or beating analyst forecasts is one of the driver, managers have every incentive to manipulate earnings or analyst forecasts in the hope to meet or beat analyst forecasts in earnings announcement. In a survey of 401 CFOs, Graham et al. (2005) show that 74% of their respondents indicate that meeting or beating analyst forecasts is important and that CFOs would take actions to avoid missing analyst forecasts or some other earnings benchmarks (e.g. earnings last year or loss).

To satisfy analyst expectations, managers could be short-sighted and take actions that could lead to long-run value destruction just in order to meet or beat analyst projections. For example, the manager could cut research and development (R&D) and capital expenditure to report higher profits, which are critical to the firm’s long-run value generation. Arthur Levitt, former chairman of SEC, expressed his concern about the increasing trend of managers’ attempts to meet or beat analyst expectations. He argued that managers are pressured to satisfy analyst expectations in that the market places a lot of weight on whether firms can meet or beat analyst projections.

In this study, we demonstrate that the market doesn’t fixate on earnings when valuing firms’ meeting or beating analyst forecast. In fact, in a sample of firms from 1990 to 2005, we find that 41 percent of firms that meet or beat analyst forecasts are followed by negative market reactions and 43 percent of firms that miss analyst forecasts are followed by positive market reactions (“the seemingly counterintuitive market reactions”). The figures are quite surprising given the current research showing that the market, on average, reacts positively to firms that meet or beat analyst forecast and negatively to firms that miss analyst forecasts.

We argue that the market prices information beyond current earnings (i.e. ‘other information’) as an explanation to the seemingly counterintuitive market reactions. Non-earnings information, such as customer satisfaction, order backlogs or patents, has implications for future earnings, even though not reflected in current earnings (Ittner and Larcker, 1998; Myers, 1999; Rajgopal et al., 2003; and Gu, 2005). In addition, Amir and Lev (1996) demonstrate that nonfinancial statement information, such as population size and market penetration, is more value relevant than financial statement information in wireless communication industry. The prior literature has also shown that firms’ concurrent disclosures and information in conference calls impact the market reactions to earnings announcements (Francis et al., 2002; Kimbrough, 2005). Since stock price is forward looking, ‘other information’ could be captured in stock price by the market when reacting to firms’ meeting or beating analyst forecasts. Collectively, unfavourable ‘other information’ is likely to negate positive earnings surprises, thus resulting in the market reacting negatively to firms that meet or beat analyst expectations. Accordingly, favourable ‘other information’ would likely counter, in part, the effects of negative earnings surprises which would lead to positive market reactions to firms that miss analyst forecasts.

Using a general proxy of other information, we find that ‘other information’ can explain the seemingly counterintuitive market reactions. Specifically, these reactions to ‘other information’ may be attributable to commonly identified factors in the literature, such as long-run growth, market risk, analysts’ forecast precision, price decreases from the prior quarter and firm size, but we find evidence that these reactions are also attributable to information contained in analyst forecasts beyond these factors.

We also examine whether the market prices ‘other information’ rationally. The literature claims that the market is overly exuberant when firms regularly meet or beat expectations, and overly pessimistic when firms miss expectations. The literature, however, has not addressed whether the market is equally as exuberant or pessimistic with its reactions to ‘other information’. We find that the market overestimates the persistence of ‘other information’. The evidence indicates that the market does not comprehend the implications of information beyond current earnings about future earnings, and tends to overreact to it.              

Overall, the consequences of capital market concerns (stock price driven motivation) for meeting or beating, or missing analyst expectations may have been overemphasised. However, the overreaction to ‘other information’ we document may be of greater concern (e.g. the market’s ability to assess other disclosures of a firm about future earnings). Although standard setters would view whether earnings information is priced rationally by the market as their main concern, whether the market prices earnings information rationally, however, partly depends on whether ‘other information’ is priced rationally.