| Author: | Ma, Linkun |
| Title: | Two essays on IPO firms’ earnings torpedo risk |
| Advisors: | Lin, Ji-chai (AF) |
| Degree: | Ph.D. |
| Year: | 2022 |
| Subject: | Stock price forecasting Stocks -- Prices Corporate profits -- Forecasting Corporations -- Finance Hong Kong Polytechnic University -- Dissertations |
| Department: | School of Accounting and Finance |
| Pages: | x, 96 pages : color illustrations |
| Language: | English |
| Abstract: | This thesis consists of two essays. The commonality of the essays is the valuation effects of missing analyst earnings forecasts as firms age. Missing analyst earnings forecasts may lead to earnings torpedoes. Earnings torpedo, as Skinner and Sloan (2002) note, is the fact that “missing analysts’ forecasts, even by small amounts, causes disproportionately large stock price declines.” This excessively large price drop reflects that the overoptimistic investors are disappointed and revise downward to the prior optimism. If young firms – firms going public recently – generally have overoptimistic investors, in the first essay, I examine whether younger firms face higher earnings torpedo risk. The second essay examines what role the accumulation of missing analyst forecasts plays in the negative relation between M/B and firm age. To sell their shares successfully or at a higher valuation, firms raise investor expectations when going public. The risk from having overoptimistic investors is obvious and well documented in literature on post-IPO long-run performance. Nonetheless, how the inferior long-run returns to IPO firms are realized is not well investigated. This thesis addresses the channel in which investors’ overly optimistic expectations formed at IPO are revised down in the post-IPO market when the realized earnings disappoint investors. Specifically, in the first essay, I examine whether younger firms face higher earnings torpedo risk. My study show that younger firms experience a disproportionately larger price drop to negative earnings surprises. The magnitude of average abnormal returns around negative earnings surprises declines from around 8% to near zero in firm age, and similar trend is not observed around positive earnings surprises. Analysts following younger firms revise analysts revise their earnings forecasts down more when the firms they follow miss analyst forecasts. Younger firms are more likely to release management forecasts to guide expectations down after missing analyst forecasts. Consequently, the likelihood of missing analyst forecasts declines as firms age. The findings support that younger firms face higher earnings torpedo risk and suggest that missing analyst forecasts may be one channel through which the overly optimistic expectations at IPO are revised. In the second essay, I examine whether missing analyst forecasts serves as one channel through which the overly optimistic expectations at IPO are revised. Specifically, I extend on Pastor and Veronesi’s learning model and investigate whether the accumulation of missing analyst forecasts in a firm plays a role in the negative relation between market valuation and firm age. Pastor and Veronesi (2003) model that expected terminal value of equity increases with uncertainty about future profitability due to the convexity of compounding; uncertainty decreases over a firm’s lifetime as information about the firm’s profitability piles up. Proxy for the declining uncertainty, firm age is negatively associated with market valuation. I argue that missing analyst forecasts both reduces uncertainty and leads to downward revisions to prior optimism formed at IPO, hence lowering firm valuation. The adverse effect should be larger due to the higher earnings torpedo risk in younger firms. This implies that, as a proxy for firm valuation, M/B and changes in M/B should be related to the frequency and timing of missing consensus analyst earnings forecast. Constructing two measures for the accumulation of missing analyst earnings forecast, I investigate the role of it in the negative relation between firm age and M/B. The two measures address the effects of both the frequency and timing on firm valuation from missing analyst forecasts. My findings show that the accumulation of missing analyst forecasts is positively associated with firm age and negatively associated with market to book ratio. More importantly, the effect of firm age on market-to-book ratio declines or diminishes after controlling the accumulation of missing analyst forecasts; the effect of firm age on the annual change in M/B declines after considering whether firms miss analyst forecasts in that year. Moreover, the accumulation of missing analyst forecasts is incremental to explain the market-to-book ratio in the cross section. My findings suggest that missing analyst forecasts is one channel through which the decline in M/B over a firm’s lifetime is realized. In sum, my two essays enhance our understanding how the downfall of IPO firms is realized and on the role of missing analyst forecasts in reshaping firms’ valuation as they age. |
| Rights: | All rights reserved |
| Access: | open access |
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