Henry L. Friedman of the University of California’s Anderson School of Management (et al.) found a unique opportunity to test whether or not management guidance helped investors to more orderly or ‘better’ markets.
In June 2020 China’s regulators dropped the requirement for companies on their GEM board to provide mandatory earnings guidance. Following the rule change 60% abandoned the practice providing an opportunity for some before and after work.
What the research uncovered was that management guidance tends to increase ‘noise’ trading around results announcements for smaller and less well covered companies which in turn increases bid-ask price spreads and raises volatility.
For these companies then guidance results in a counter-intuitive decrease in market quality. Shareholders are not provided with any advantage in this process, in fact, they suffer as a consequence.
In addition the work highlights:
- Short term earnings guidance does not appear to trigger earnings manipulation
- The pick-up in noise trading is almost certainly the product of increased visibility. Something some companies might appreciate
- The effect is most noticeable with small and poorly covered companies. This effect is NOT visible among larger companies
The conclusion here is that management guidance is not always and everywhere a good thing. The ‘more information is better information’ notion doesn’t hold in many cases as it triggers externalities that are unhelpful for promoting a ‘quality’ market.
You can access the paper in full here How Does Management Guidance Affect Investors’ Responses to Earnings Announcements?
Happy Sunday.