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Faculty & Research


Long-Term Earnings Forecasts, Shifting Segment Earnings, and Stock Returns (Revision 2 )

Working Paper
The authors document that the negative relation between long-term expected earnings growth (LTG) and future stock returns is amplified by managerial manipulation of earnings. They isolate the price effects of manipulation from biased investor extrapolation of LTG using the inter-segment distortion of earnings in conglomerates. The underperformance in high LTG conglomerates is particularly pronounced in firms that manipulate segment earnings, with an annual alpha of -10% for high-minus-low LTG firms. This predictive effect accentuates under conditions of high shorting constraints or positive investor sentiment. Difference-in-difference analyses, leveraging SFAS 131 disclosure requirements, reveal analysts’ forecasts of LTG are unaffected by segment-level profit distortions in conglomerates, distinguishing overpricing due to managerial manipulation from over-extrapolation of LTG. Consistent with the sentiment effects, mutual funds increase their active holdings in these manipulated conglomerates and experience subsequent long-term underperformance.

Professor of Finance