Determinants of Management Earnings Forecasts: The Case of Global Shipping IPOs

• Published date: 01 October 2017
• Date: 01 October 2017
• DOI: http://doi.org/10.1111/eufm.12121

Determinants of Management

Earnings Forecasts: The Case of

Global Shipping IPOs

Wolfgang Drobetz

Faculty of Business Administration, Hamburg University, 20148 Hamburg, Germany

E-mail: wolfgang.drobetz@uni-hamburg.de

Dimitrios Gounopoulos

Newcastle University Business School, Newcastle University, Newcastle upon Tune, NE1 4SE, UK

E-mail: dimitrios.gounopoulos@ncl.ac.uk

Anna Merika

Department of Economics, The American College of Greece, 6 Gravias Street, Agia Paraskevi, 15342 Greece

E-mail: merikas@otenet.gr

Andreas Merikas

Department of Maritime Studies, University of Piraeus, Piraeus, Greece

E-mail: amerikas@unipi.gr

Abstract

Firms that go public on global stock markets are not obliged to disclose earnings

forecasts in their prospectuses. We use this fact to examine the shipping industry,

where most firms voluntarily issue earnings forecasts during the IPO process, thus

providing unique, international-level evidence. We find overall pessimistic

forecasts of ship owners, primarily because of the industry’s uncertain and

volatile environment. High ship owner participation after going public is

associated with less accurate earnings forecasts. Our results further indicate that

financial leverage, a listing in an emerging stock market, and global market

conditions are other main factors responsible for inaccurate earnings forecasts.

Keywords: earnings manage ment, voluntary disclosure en vironment, forecast

accuracy, IPOs

JEL classification: D82,G14,G32,M41

The authors are grateful to John Doukas (Editor), Biki Jaggi, Ranko Jelic, Tim Loughran,

Paul McGuinness, Mikelle Meoli, Nikos Paltalidis, Silvio Vismara two anonymous referees

and conference participants at the European Accounting Association (EAA) in Ljubljana

and seminar participants at the University of Hamburg, University of Sussex and Newcastle

University for their comments and suggestions for their comments and suggestions. We

thank Alexandrine Petridis for excellent research assistance.

European Financial Management, Vol. 23, No. 5, 2017, 975–1015

doi: 10.1111/eufm.12121

© 2017 John Wiley & Sons, Ltd.

1. Introduction

Management earnings forecasts represent one of the most important sources of

information about listed companies and initial public offerings (IPOs) (Clarkson et al.,

1992; Baginski et al., 2002; Jogand McConomy, 2003; Baginski et al., 2004; Hirst et al.,

2008; Godman et al, 2014). Beyer et al. (2010) report that approximately 55% of the

accounting information available to US investors comes from such forecasts.

1

Today,

the popularity of voluntarymanagement earnings forecasts in the US has also become the

dominant disclosuremechanism worldwide.

2

Huang et al. (2014) indicatethat its mandate

was one of the most significant corporate disclosure decisions in history, especially for

small investorswho have limited access to privateinformation. Disclosure reducesthe cost

of capital for firms, and it can combatproblems like asymmetric information and agency

problems (Dye, 1985; Healy and Palepu, 2001). Moreover, it enhances transparency,

building firms’positivereputations and contributingto an expansion in their investorbase.

In this study, we exploit the fact that a great proportion of global shipping firms

voluntarily choose to issue IPO earnings forecasts. The policy of issuing earnings

forecasts has drawn the attention of finance researchers because of its influence on

investor decisions. Within transportation research, the interest in the various facets of

financial reporting has been ongoing, with a focus on, e.g., alternative accounting policy

choices (Tan et al., 2002), intangible assets reporting (Lev, 2003), and managerial

discretion in assessing the reliability of financial reporting.

However, two factors received less attention in the analysis of financial reporting and

disclosure of earnings forecasts in the transportation industry: 1) the quality of the signal

that firms wish to transmit through earnings announcements to the financial markets and

consequently to potential investors, and 2) how the institutional setting serves to protect

potential investors from being misled. The motivation for our study stems primarily from

this gap in the literature.

The shipping industry, with its global, highly competitive, and extremely volatile

nature, is distinct.

3

The majority of shipping companies that implemented an IPO

1

In 2010 alone, approximately 4,500 annual earnings forecasts were issued by 950 US firms,

according to First Call’s company-issued guidelines database.

2

The majority of capital markets worldwide allow voluntary disclosure of management earnings

forecasts, although, in the past, some countries mandated the practice (e.g., Canada, Greece and

Malaysia). Over the years, and largely because of significant forecasting errors, most local capital

market commissions recommended that earnings forecasts become solely voluntary.

3

The definition of shipping we use refers to all listed companies in the shipping sector on

major world exchanges, and it includes all corporations that own and/or operate ships,

regardless of what subsector they belong to. Our study does not capture technical

specifications or cargo, thus, we do not distinguish among different segments of the shipping

industry. In general, the maritime industry is comprised of companies whose activities supply

innovative services and products related to the traditional maritime sector. The shipping

industry includes all enterprises engaged in the business of designing, manufacturing,

constructing, operating, acquiring, supplying, repairing and/or maintaining vessels, or

components thereof, such as managing and/or operating shipping lines, customs brokerage

services, shipyards, dry docks, marine railways, marine repair shops, shipping and freight

forwarding services, and similar enterprises.

© 2017 John Wiley & Sons, Ltd.

976 Wolfgang Drobetz, Dimitrios Gounopoulos, Anna Merika and Andreas Merikas

voluntarily announced their forecasted profits in their prospectus, thus contributing to the

rise of a generally accepted regulatory system for corporate behaviour. Nevertheless,

many difficulties in forecasting earnings persist, because the industry is characterised by

long-term investments and criticalities in accounting decisions (e.g., cost capitalisation,

depreciation and residual value, and leasing) (Godman et al., 2014).

The importance of shipping lies in the fact that it constitutes an integral part of

international trade. IPOs can provide shipping firms with critical resources for future

expansion. They can secure the financial position of ship owners by providing them with

their first substantial access to cash. The IPO prospectus provides potential investors with

information that ought to help them when making their investment decisions. It is

common practice among shipping firms to make foreign listings due to the globalised

nature of the industry, forcing managers to address the pronounced information

asymmetries caused by the practical difficulties of information penetration among

international investors.

One of the mechanisms that enables companies to reduce these information

asymmetries is the disclosure of earnings forecasts in their prospectuses (Jaggi et al.,

2006). To develop a better understanding of the relationship between management

earnings forecasts and their informational context in a globalised environment, a

comprehensive analysis of the forecast characteristics is necessary. For example, do

maritime IPOs report biased forecast earnings? Or, do they overstate or understate the

information contained in their economic variables? In this article, we are particularly

interested in US-listed shipping IPOs. However, we also aim to determine whether there

are any major differences compared to our international sample.

We compute earnings forecas t errors and find pessimistic fore casts for the large

majority of shipping IPOs. From our sample, we then iden tify the US-listed

companies, and observe tha t NYSE-listed IPOs tend to an nounce pessimistic earni ngs

in their prospectuses, whil e Nasdaq-listed IPOs provi de relatively more optimist ic

forecasts. Companies that dis close earnings forecasts pri or to an IPO left less money

on the table when measured b y the degree of underprici ng. Overall, contrary to t he

existing US literature, our fin dings indicate that ship owner s and their management

tend to provide pessimist ic earnings forecasts, tha t is, actual earnings exc eeded

forecasted profits. We attribute this finding primarily to the sector’s highly volatile

environment.

We then proceed by studying the factors that determine the quality of forecasted

earnings and assemble our main hypothesis. The factors that affect forecasted earnings

quality come from three sources: 1) firm-specific idiosyncratic factors such as financial

leverage, size, concentrated ownership, and age, 2) market-related factors such as the

state of the shipping and stock markets, and 3) institutional factors such as Generally

Accepted Accounting Principles (GAAP) and the mandatory application of International

Financial Reporting Standards (IFRS). We develop a general-to-specific (GETS) model,

based on Henry et al. (2013), and within it, use Lewbel’s (1997) methodology. Through

model evaluation and reduction we end up with a well-specified model that allows us to

extend the existing literature on earnings forecasts.

We also examine robustness for the location of the listing (domestic versus foreign)

and the legal system (common versus civil law). Shipping IPOs experience higher

forecast errors when they choose to list abroad rather than in their home country. Among

foreign listings, there exists an overly high forecast inaccuracy for young, small, and

highly financially leveraged shipping companies. To address legal system effects, we test

© 2017 John Wiley & Sons, Ltd.

Management Earnings Forecasts around IPOs 977