Industry Peer Competition and Management Earnings Forecasts

• Published date: 01 October 2022
• Author: Lin Chen,Dongfang Nie,Yuan Shi
• Date: 01 October 2022
• DOI: http://doi.org/10.1002/jcaf.22576

Received:  January  Revised:  June  Accepted:  June 

DOI: ./jcaf.

RESEARCH ARTICLE

Industry Peer Competition and Management Earnings

Forecasts

Lin Chen1Dongfang Nie2Yuan Shi3

Valparaiso University, Valparaiso,

Indiana, USA

University of Texas PermianBasin,

Odessa, Texas,USA

Penn State Great Valley,Devault,

Pennsylvania, USA

Correspondence

Dongfang Nie, University of Texas

Permian Basin, Odessa, Texas,USA.

Email: nie_d@utpb.edu

Abstract

This study examines the effect of industry peer competition on management

earnings forecasts in the U.S. product markets. Our probit model estimations

show that industry peer competition is positively associated with the likelihood

and frequency of quarterly management earnings forecasts. Further, this effect

is more pronounced for firms that are leaders in sales and for firms with R&D

activities that use voluntary disclosure to reduce information asymmetry. Using

a Heckman model, we further find that the likelihood of point forecasts versus

range forecasts is negatively associated with industry peer competition, and this

effect is more pronounced for firms that are leaders in sales and for firms with

R&D activities. These findings suggest that firms with high proprietary costs are

less likely to issue precise forecasts.

KEYWORDS

disclosure, management earnings forecasts, peer competition

1 INTRODUCTION

Prior studies examining the relation between product mar-

ket competition and firms’ management earnings forecasts

have produced mixedresults. On the one hand, proprietary

cost theory suggests that a firm is less likely to disclose

private information because its competitors could gain

advantages at the firm’s “proprietary cost” (Leuz & Ver-

recchia, ). Consistent with this theory, studies find

that product market competition discourages voluntary

disclosure using the Herfindahl-Hirschman Index (HHI)

as a measure of industry level competition (Li, ). On

the other hand, Ali, Klasa, and Yeung () suggest the

opposite is true using the census industry concentration

ratio to measure industry level competition. The conflict-

ing results in these and many other studies indicate that

consensus has not been reached concerning the effects

of product market competition on management earnings

forecasts. Part of the reason is that both HHI and cen-

sus concentration ratio are noisy and indirect measures of

competition (Lang & Sul, ). To overcome the afore-

mentioned challenge, we propose another type of product

market competition each firm faces within the same indus-

try: industry peer competition (the competition from a

firm’s closest rival in a given industry).

The industry peer competition concept is based on

the idea that the smallest absolute market share differ-

ence between one firm and its closest competitor (market

sales difference) can be used to measure the competition

between the two firms (Bills & Stephens, ;Keune,

Mayhew, & Schmidt, ; Newton, Persellin, Wang, &

Wilkins, ; Numan & Willekens, ). The industry

peer competition concept captures the intensity of com-

petition between a firm and its closest competitor in the

product market. The intensity of competition increases

when the market sales difference decreases. In the audit-

ing literature, researchers use the marketshare (audit fees)

difference to measure the level of competition between

two audit offices in the same metropolitan statistical area

(MSA) (Bills & Stephens, ; Keune et al., ;Newton

J Corp Account Finance. ;:–. ©  Wiley PeriodicalsLLC. 191wileyonlinelibrary.com/journal/jcaf

192 CHEN  .

et al., ; Numan & Willekens, ). These studies have

validated the relation between industry peer competition

and audit outcomes such as audit fees and internal control

opinion shopping.

In the context of management earnings forecasts, Lin,

Mao, and Wang () show that firms compete with

their peers for capital by increasing management earn-

ings guidance. Answering the call of Lin et al. (), we

investigate the effect of industry peer competition on man-

agement earnings forecasts. Our measure of industry peer

competition differs from theirs. Anecdotal evidence sug-

gests that a firm competes with its closest competitor in

the product market. For instance, as the leader in the

smartphone industry,Apple Inc.’s earnings forecasts could

convey industry demand information to Samsung, its clos-

est competitor. This is because Apple and Samsung are in

close competition for the title of top smartphone seller.On

the one hand, the proprietary cost concern is high when

the competition between Apple and Samsung is high. On

the other hand, the competition for capital is high when

Apple and Samsung compete extensively in the product

market.

Industry peer competition is a firm level measure dif-

ferent from HHI and census concentration ratio that are

industry level measures for competition. While the indus-

try level measure is the same for a given industry, the firm

level measure differs among firms in the industry. While

the industry level measure is only able to explain disclosure

variations across industries, industry peer competition can

explain the disclosure variations between firms. Prior stud-

ies ignore industry peer competition, an important type

of competition that one firm faces in addition to the

industry level competition. However, it is possible that

when the industry level competition is high, the firm level

competition (peer competition) will be high as well. In

this study, we fill this void by studying the incremental

power of industry peer competition beyond industry level

competition measured using HHI.

Our sample is restricted to U.S. public firms for the

period –. The sample consists of , firm-

quarter observations and , observations that have

quantitative management forecasts. Using a probit model,

we find that the likelihood and frequency of management

earnings forecasts are positively associated with indus-

try peer competition, after controlling for HHI. Using a

Heckman model, we further find that management fore-

cast precision is negatively associated with industry peer

competition, after controlling for HHI.

We further classify our sample to leaders versus follow-

ers groups using market share ranking. We also divide the

sample into a group with R&D expenditures and a group

without R&D expenditures. We conduct cross-sectional

analyses and find that the positive effect of industry peer

competition on forecasts likelihood and frequency is only

significant for leaders group and the group with R&D

expenditures. Specifically, firms in the leader position are

more likely to issue earnings forecasts when they face high

level of peer competition. Meanwhile, the leaders group

and the group with R&D expenditures are less likely to

issue precise point forecasts. One possible explanation is

that the proprietary costs of precise forecasts are higher for

these two groups of firms.

We contribute to the literature on product market

competition and management earnings forecasts. Insights

from this study are important because firms often bench-

mark with their closest competitor. Prior studies examine

the effect of competition on management forecasts mainly

focus on the industry level. Our paper differs from prior

work because we measure the effect of the closest peer

firm’s competition on one firm’s disclosure, controllingfor

the industry level competition measure using HHI. Our

findings suggest that a firm’s decision to make earnings

forecasts is affected by its closest peer firm.

2LITERATURE REVIEW AND

HYPOTHESES

2.1 Literature review

.. Importance of management earnings

forecasts

In the U.S., firms provide earnings guidance voluntarily.

Earnings guidance is one of the most important voluntary

disclosure mechanisms that managers use to convey earn-

ings expectations. Prior literature finds that managers use

earnings guidance to mitigate litigation risk, to reduce cost

of capital, and to enhance management reputation (Hirst,

Koonce, & Venkataraman, ). In addition, earnings

guidance has other consequences such as moving stock

prices, affecting managers’ earnings management, improv-

ing financial analysts’ information environment (Baginski

& Hassell, ; Coller & Yohn, ; Fuller & Jensen,

).

This paper focuses on management earnings forecast

for several reasons. First, management earnings fore-

cast is one of the most important and heavily studied

types of voluntary disclosure that has attracted atten-

tion from accounting researchers (Hirst et al., ).

Second, management earnings forecast is a key source

of forward-looking information that the capital market

relies upon (Bozanic, Roulstone, & Van Buskirk, ).

Third, earnings guidance reveals managers’ ability to

anticipate macro economy environment changes (True-

man, ). Managers make both quarterly and annual