Long vs. Short Term
It should come as no surprise to us that short term earnings get an extraordinary amount of attention. The majority of firms view earnings, especially EPS (earnings per share), as the key metric for investors (market reaction), even more so than cash flows. Missing an earnings target is so risky for managers that they are willing to sacrifice economic value in order to meet a short-run earnings target. The preference for smooth earnings is so strong that 78% of the executives would give up economic value in exchange for smooth earnings. 55% of managers would avoid initiating a very positive NPV project if it meant falling short of the current quarter’s consensus earnings. Missing an earnings target or reporting volatile earnings is thought to reduce the predictability of earnings, which in turn reduces stock price because investors and analysts hate uncertainty. Managers make voluntary disclosures to reduce information risk associated with their stock but try to avoid setting a disclosure precedent that will be difficult to maintain.