The effect of earnings forecast precision on firm value and insider trading under voluntary disclosure in Taiwan
37
management. Since earnings forecast manipulation is difficult to observe, this study uses earnings management as the proxy of forecast manipulation. This study follows Dechow et al. 1996 Leuz, et al. 2004 to compute the
accrual components of earnings:
it it
it it
it it
it
Accruals CA
Cash CL
STD TP
Dep =
− −
− −
− +
+ +
+ +
3 Where,
ΔCA
it
is the change in total current assets of firm i at time t; ΔCash
it
is the change in cash equivalents; ΔCL
it
is the change in total current liabilities; ΔSTD
it
is the change in short-term debt included in current liabilities; ΔTP
it
is the change in income tax payable; and Dep
it
is depreciation and amortization expenses. Another measure of total accruals, TAC
2
, is defined as the difference between earnings from continuing operations and cash flow from operations. In line with Bhattacharya, et al. 2003, this study measures earnings management of firm i at
time t of Accruals divided by total assets in the prior quarter:
1
1
it it
it
EM Accruals TA
−
=
4
2 1
2
it it
it
EM TAC
TA
−
= 5
4. Empirical analysis
4.1 Sampling and data sources
The sample includes Taiwanese publicly listed companies that disclose earning forecasts voluntarily. The sample period runs from 2005 to 2008. This period is selected because it witnessed the introduction of a new
policy regarding earnings forecast disclosure in Taiwan. The voluntary forecasts and financial data were retrieved from the Taiwan Economic Journal TEJ database and the Market Observation Post System of the Taiwan Stock
Exchange. The total sample includes 154 firms, with 97 disclosing earnings forecast in 2005 while only 34 did so in 2006. Eight firms adjusted reported earnings upward, and twenty-eight firms revised their earnings forecasts
downward, including six firms that issued two downward revisions of earnings forecasts. Most of the sample firms 74 did not violate the 20 percent forecast error threshold. Table 1 gives the description of the sample.
Table 1 The description of the sample
Types of financial forecast Taiwan Stock Exchange
GreTai Exchange 2005 2006 2007 2008 2005 2006 2007 2008
Complete financial forecast
No revision 5 1 3 2 12 1 0 0
Upward once 2 0 0 0 2 0 0 0
Downward once
2 1 0 0 8 0 0 0 Downward
twice 2 0 0 0 0 0 0 0
Number of firms 11
2 3
2 22
1 Summary
financial forecast No
revision 32 13 5 6 21 10 1 2 Upward
once 1 0 1 0 2 1 0 0 Downward
once 4 3 0 0 3 1 3 0
Downward twice
0 3 0 0 1 0 0 0 Number
of firms
37 19 6 6 27 12 4 2 Notes: This table indicates number of observations that voluntarily disclose earnings forecast. The sample includes Taiwanese
publicly listed companies that disclose earnings forecast voluntarily. The sample period runs from 2005 to 2008. This period is selected because it witnessed the introduction of a new policy regarding earnings forecast disclosure in Taiwan. The total sample
includes 154 firms that voluntarily disclosed earnings forecast.
The effect of earnings forecast precision on firm value and insider trading under voluntary disclosure in Taiwan
38
4.2 Return structure of forecast revision
In the empirical analysis of forecast revision on stock returns, I first investigate the Abnormal Return AR and Cumulative Abnormal Return CAR. Market adjusted return is used as the abnormal return. As is
documented in Figure 1, the abnormal returns are negative around the announcement date of the first downward revision. The cumulative abnormal return is about -7 during four days after announcement. However, the
abnormal returns are first positive and then turn negative later on after the announcement date of upward revision in Figure 2.
-8 -7
-6 -5
-4 -3
-2 -1
1 2
-20 -18 -16 -14 -12 -10 -8 -6 -4 -2 2
4 6
8 10 12 14 16 18 20
the date of the first downward revision re
tu rn ra
te
AR CAR
Figure 1 Abnormal Return AR and Cumulative Abnormal Return CAR around the announcement date of the first downward revision.
-3 -2
-1 1
2 3
4 5
6
-20 -18 -16 -14 -12 -10 -8 -6
-4 -2
2 4
6 8
10 12 14 16 18 20
the date of the upward revision ret
u rn
rat e
AR CAR
Figure 2 Abnormal Return AR and Cumulative Abnormal Return CAR around the announcement date of the upward revision.
4.3 Firm value and earnings forecast error
Listed companies in Taiwan are required to release quarterly financial statements, in addition to annual reports in April of each year. Semiannual reports are released in August. In order to test the model prediction that
forecast error under voluntary disclosure reduces firm value, I estimate the relationship between firm value and
