Zhihong CHEN Department of Accountancy The City University of Hong Kong

1. Discussion of “Does the stock market see a zero or small positive earnings surprise as a red flag?” Zhihong CHEN Department of Accountancy The City University of Hong Kong

2. Summary of Findings • Investigate whether investors and analysts see zero or small positive earnings surprise (MBE) as indicator of earnings management. • ERC is significant lower for MBE firms in late 1990s and early 2000s but not in early 1990s. • AERC is insignificant in early 1990s and significantly negative in late 1990s and early 2000s for MBE firms. • MBE firms are associated with lower than expected returns in the post-earnings-announcement period.

3. Motivation and Contribution • What is the Null Hypothesis? • Investors may rely on zero or small positive earnings surprise to identify earnings management. • Academic research suggests that firms manipulate earnings and/or expectations to meet or beat earnings target. • It is difficult for investors to detect earnings manipulation. • Looking at forecasts trajectory is not reliable. • Why investors may not rely on such subtle clues? • Why do we need an empirical test without a credible null hypothesis? • Link to the existing literature? • Investors’ response is key knowledge to understand firms’ behavior. • May provide more discussion of prior literature (e.g., Bartov et al. (2002, JAE), Brown and Caylor (2005, TAR)).

4. Research Design • Use IBES Detail File • Precise proxy for earnings expectation • Use preannouncement period CAR to proxy for expectation change may not be enough • Marginal cost of using detail file is not high • Regression Specification • CAR (FREV) = a + b*D*ES/P + c*Control*ES/P + e • Dummies for SE ranges and control variables should be included in the intercept • Forcing intercepts identical may inflate slop estimates for observations with larger magnitude of ES/P. • The rationale of using [-1,0) as benchmark? • Firms unable to meet earnings expectation may be perceived as having big trouble (Graham et al. (2004)) • Confounding events during 1998-2004 • To what extent the results are driven by bubble (burst) in this period?

5. Several Related Issues • Are skepticisms of investors and analysts justified? • Declining ERC and AERC are associated with increasing frequency of zero or small positive earnings surprise. • Increasing frequency of zero or small positive earnings surprise does not necessarily mean more (opportunistic) earnings/expectation manipulation • Are zero or small positive earnings surprises associated with lower future accounting performance? • What is the involving picture? • Brown and Caylor (2005, TAR) show that after mid-1990s, managers put avoiding negative earnings surprise as first priority. • Before mid-1990s, avoiding quarterly earnings decrease is put at first priority. • Are the findings documented in this paper a part of a bigger picture? • Investigating pre-1992 data and quarterly earnings change may help? • If the benefit of MBE declines, what will firms do? What is the picture in equilibrium?

6. Minor Issues • Why use dummy transformation of control variables? • Transform into high/low dummy loses information • Compared with 1992-1997, in 1998-2004, ERCs for all positive ES ranges are larger (table 4 and 6), but AERCs do not have such pattern. What does it imply? • The results are little bit sensitive to scaling variable of ES. • T-stats may need adjustment .

7. Conclusion • An interesting and well-executed study. • Enhance our understanding of MBE. • May think more of the null hypothesis. • More discussion of the links to the existing literature. • Research design issues.