A new study finds that investors are not only skeptical of upbeat financial forecasts from the management at public companies, but they often believe downbeat forecasts are overly optimistic and less credible than positive news about the company's outlook.
Presented at the annual meeting in August of the American Accounting Association, the study concludes that the market's stronger reaction to bad news "likely reflects the discounting of a bad-news management forecasting due to its lower, rather than higher, credibility."
In other words, investors "perceive bad news as less credible (i.e., more optimistically biased) than good-news management forecasts and discount bad news accordingly. As the actual news could be worse than that given by management, this discounting means more negative reaction to bad news."
The reason for this credibility gap, according to the study's author, Helen Hurwitz of Columbia University, is that companies are far less likely to get sued for pulling their punches when issuing bad-news predictions than for issuing rosy forecasts that later prove to be too rosy: "It is more difficult to sue a firm for issuing too-optimistic bad-news forecasts."
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