The effect of meeting or beating revenue forecasts on the association between quarterly returns and earnings forecast errors

Recent studies in the accounting literature provide evidence of an equity price premium whenever firms meet or exceed analysts' earnings forecasts. That is, the market perceives the act of meeting earnings forecasts as a signal about future firm performance. Financial analysts typically issue revenue forecasts in addition to earnings forecasts. In this study, we examine whether meeting or exceeding revenue forecasts serves as an additional signal to the market in pricing earnings performance. Consistent with our hypotheses, we show that the market premium (penalty) to meeting or beating (not meeting) earnings forecasts is accentuated when revenue forecasts are also met (not met). In fact, the premium to meeting earnings forecasts is completely eliminated when revenue forecasts are missed. Consistent with previous research, we document a significant association between revenue forecast errors and quarterly abnormal returns. However, we show that this association becomes insignificant after allowing for shifts in the equity price premium depending on whether earnings and revenue forecasts are met. Thus, the value of meeting revenue forecasts is arguably of greater importance to market participants than the magnitude of the revenue forecast error. Finally, we find some evidence that the magnitude of the earnings response coefficient jointly depends on whether the earnings and revenue forecasts are met or not; however, this result is not robust to a nonlinear specification of the association between returns and forecast errors.