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Journal of Accounting and Economics 39 (2005) 509533 www.elsevier.com/locate/jae

To blame or not to blame: Analysts reactions to external explanations for poor nancial performance$
Jan Barton, Molly Mercer
Goizueta Business School, Emory University, Atlanta, GA 30322, USA Received 3 March 2003; received in revised form 17 March 2005; accepted 4 April 2005

Abstract Managers often provide self-serving disclosures that blame poor nancial performance on temporary external factors. Results of an experiment conducted with 124 nancial analysts suggest that when analysts perceive such disclosures as plausible, they provide higher earnings forecasts and stock valuations than if the explanation had not been provided. However, we also show that these disclosures can backre if analysts nd them implausible. Specically, implausible explanations that blame poor performance on temporary external factors lead

We appreciate the helpful comments of Holly Ashbaugh, Charlie Bailey, Sudipta Basu, Robert Bloomeld (the referee), Jennifer Joe, Jay Koehler, Mark Kohlbeck, Lisa Koonce, Bob Lipe, Stan Markov, Ella Mae Matsumura, Brian Mayhew, Jeff Miller, Pam Murphy, Lisa Sedor, Siew Hong Teoh, Kristy Towry, Terry Wareld, Greg Waymire, Jerry Zimmerman (the editor), and seminar participants at University of Georgia, Harvard University, University of Notre Dame, Ohio State University, Rice University, University of WisconsinMadison, the 2003 AAA Financial Accounting and Reporting Section midyear meeting, and the 2004 AAA annual meeting. We also gratefully acknowledge those who gave generously of their time participating in this study and the Goizueta Business School for its nancial support. Corresponding author. Tel.: +1 404 727 7079; fax: +1 404 727 6313. E-mail addresses: jan_barton@bus.emory.edu (J. Barton), molly_mercer@bus.emory.edu (M. Mercer). 0165-4101/$ - see front matter r 2005 Elsevier B.V. All rights reserved. doi:10.1016/j.jacceco.2005.04.006

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analysts to provide lower earnings forecasts and assess a higher cost of capital than if the explanation had not been provided. r 2005 Elsevier B.V. All rights reserved.
JEL classication: D8; G1; M4 Keywords: Voluntary disclosure; Management explanations; Financial analysts earnings forecasts; Management reputation; Financial reporting credibility

1. Introduction Even the most casual review of corporate disclosures suggests that managers tend to blame poor nancial performance on temporary external factors (Morgenson, 2004). For example, rms as diverse as Ford Motor, Winn-Dixie, WebMD and Delta Air Lines blamed negative earnings surprises on the September 11, 2001 terrorist attacks. The academic literature conrms these tendencies, showing that supplemental disclosures in both annual reports (Bettman and Weitz, 1983; Staw et al., 1983) and quarterly earnings forecasts (Baginski et al., 2000, 2004) tend to attribute poor performance to temporary external factors. Managers presumably offer these self-serving explanations to enhance capital market participants perceptions of managements ability and the rms prospects; however, there is little systematic evidence on how market participants actually react to such disclosures. This paper develops and tests several hypotheses regarding how nancial analysts respond to management explanations that blame poor performance on temporary external factors. Because managements performance explanations are nonbinding and difcult to verify, it is possible that analysts will regard these disclosures as cheap talk and ignore them. However, recent studies suggest that analysts use managements explanations when assessing rms prospects (Rogers and Grant, 1997; Clarkson et al., 1999). We draw on this literature, as well as on research in psychology, to develop predictions about how analysts react to managements performance explanations. Anecdotal evidence suggests that not all management explanations are perceived as plausible. Consider, for example, some rms claims that the September 11 terrorist attacks were responsible for their poor nancial results. When insurers, airlines and tourism-related rms made this claim, most analysts accepted the explanation as plausible (Farrell, 2001). However, when supermarket chain Winn-Dixie attributed its poor performance to the attacks, one prominent nancial analyst said, I have a hard time believing this could have had any kind of impact on their results (Farrell, 2001). Analysts expressed similar skepticism in response to Callaway Golfs disclosures blaming poor performance on the winds of El Nino and Krispy Kremes disclosures blaming poor performance on low carbohydrate diet fads (Perry et al., 2001; Groom, 2004).

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Although analysts may be skeptical of self-serving management disclosures, this does not necessarily mean that the disclosures will be disregarded. We expect analysts instead to assess the plausibility of managements explanations and to draw inferences about the rm based on this assessment. Specically, we predict that when analysts receive plausible explanations blaming poor performance on temporary external factors, they will forecast higher earnings than if the explanation had not been provided. Predictions about analysts reactions to implausible explanations are less clear cut. Both game theoretic models of strategic disclosure in economics and belief-updating models in psychology suggest that analysts will simply ignore implausible explanations (e.g., Crawford and Sobel, 1982; Hogarth and Einhorn, 1992). However, recent research in psychology gives reason to believe that implausible external explanations may lead analysts to make negative inferences about the rms prospects (McKenzie et al., 2002). Specically, analysts may infer that conditions at the rm must be especially bleak if management cannot provide a more credible explanation for the poor performance. If this occurs, management explanations that blame poor performance on temporary external factors will increase analysts beliefs that the performance will persist. Therefore, implausible external explanations, which are offered to promote a more favorable interpretation of the poor performance, may backre and result in lower earnings forecasts than if the explanation had not been provided. We expect these earnings forecast effects to ow through to analysts stock valuations. In addition, we expect managements performance explanations to affect valuations through analysts beliefs about the rms cost of capital. Specically, we predict that plausible performance explanations will improve managements reporting reputation, while implausible performance explanations will harm managements reputation. Because managements reputation affects its ability to communicate credibly with investors, changes in managements reputation will inuence the rms information risk. Recent evidence suggests that information risk is not fully diversiable and thus affects the rms cost of capital (Botosan, 1997; Easley et al., 2002; Francis et al., 2004, 2005). Therefore, we predict that the plausibility of managements performance explanations will affect its reputation with investors, and these changes in reporting reputation, in turn, will inuence the rms cost-of-capital. We test our predictions by conducting an experiment with 124 experienced nancial analysts. We randomly assign analysts to one of three conditions: a plausible explanation condition, an implausible explanation condition, and a control condition. All analysts receive historical nancial statement information about a rm that experienced poor performance in the most recent year. Analysts in the plausible and implausible conditions also receive managements explanation for the poor performancethese explanations blame the rms lackluster results on a temporary external event, but differ in plausibility. Our results show that analysts in the plausible explanation condition are more likely to believe that the poor performance is temporary and forecast higher earnings than analysts in the control condition. However, we nd no evidence that plausible

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explanations improve managements reputation with analysts. A potential reason for this latter result is that analysts expect managers to provide plausible performance explanations. In other words, providing plausible explanations may not be considered above and beyond behavior, so analysts are unwilling to reward managers who provide such disclosures. Given these reputation results, we should not observe different cost of capital estimates for analysts in the plausible and control conditions. Consistent with this, the earnings valuation multiples used by analysts in the plausible condition do not differ signicantly from those in the control condition. In contrast, we nd that implausible explanations for poor performance affect both earnings forecasts and earnings valuation multiples, though not in the direction presumably intended by managers. Analysts in the implausible explanation condition believe that the poor performance is more likely to persist and forecast lower earnings than those in the control condition. Thus, external explanations, which are offered to promote a more favorable interpretation of the rms performance, backre and result in a less favorable interpretation. Moreover, these implausible explanations harm managements reputation, causing analysts to use lower earnings multiples when valuing the rm. Our study makes several contributions to the literature. First, we provide evidence on how nancial analysts respond to managements explanations for poor corporate performance. Prior archival research provides little guidance on how analysts react to different types of performance explanations. One reason for the lack of evidence on this issue is that managements explanations are generally part of a larger disclosure package (Clarkson et al., 1999). For example, a rms Management Discussion and Analysis (MD&A) contains multiple disclosures explaining various components of the rms results. Similarly, earnings releases simultaneously report the rms nancial results and a series of explanations for those results. Our experimental approach allows us to hold constant all other rm disclosures and thus to isolate the effects of one specic type of management explanation. An additional advantage of our experimental approach is that it helps us unravel the process by which management explanations for poor performance affect analysts estimates of rm value (Libby et al., 2002). Fig. 1 provides a schematic description of this process. We argue that explanations that blame poor performance on temporary external factors affect analysts valuations in two ways: (1) through their effect on the perceived persistence of poor performance which, in turn, affects analysts earnings forecasts; and (2) through their effect on managements reputation which, in turn, affects analysts beliefs about the rms cost of capital. Our tests of the role of management reputation in analysts valuation judgments may be especially instructive. It is difcult to directly measure reputation using archival data, so any reputation effects must be inferred (Dechow et al., 1996; Healy et al., 1999). By conducting an experiment, we are able to elicit analysts beliefs about management and thereby offer a more direct test of the role of management reputation in valuation. The rest of the paper proceeds as follows. Section 2 develops our predictions. Section 3 describes the experiment used to test these predictions, and Section 4

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Perceived persistence of poor performance

Earnings per share forecast

Plausibility of explanation blaming poor performance on temporary external factors

Stock value

+
Management reputation

Cost of capital

Fig. 1. Summary of predictions. Plus (+) signs indicate positive relations and minus signs indicate negative relations. For example, we predict that if management provides more plausible explanations, analysts will perceive the poor performance to be less persistent and management to be more reputable (+).

reports the results. The nal section summarizes and discusses the studys practical and theoretical implications. 2. Background and hypotheses Performance explanations are a key component of a rms disclosure strategy. The Securities and Exchange Commission requires managers of public companies to explain their rms nancial results in the MD&A section of the annual report (SEC, 1980). Many managers also voluntarily provide performance explanations in venues such as letters to shareholders, earnings announcements, conference calls, and corporate presentations. There are a number of reasons why managers might want to voluntarily provide performance explanations. Increased disclosure results in a lower cost of capital (Botosan, 1997; Sengupta, 1998), so managers may provide performance explanations to reduce the rms cost of capital.1 Further, managers may use these explanations to inuence how analysts, investors, and the board of directors interpret the rms results.
1 Increased disclosure can lower the cost of capital by enhancing stock market liquidity (Amihud and Mendelson, 1986; Diamond and Verrecchia, 1991) and by reducing nondiveriable information risk (Barry and Brown, 1985; Easley et al., 2002; OHara, 2003; Easley and OHara, 2004).

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Managements performance explanations typically have low direct costs, do not constrain managers future actions, and are difcult to verify ex post. Consequently, some researchers have argued that analysts and investors will view these explanations as cheap talk (Bhattacharya and Krishnan, 1999).2 Theoretical models show that cheap talk disclosures can convey information effectively if the incentives of the message sender and the message receiver are strongly aligned (Crawford and Sobel, 1982; Farrell, 1995; Farrell and Rabin, 1996). However, it seems unlikely that managements incentives are highly aligned with those of analysts and investors when it comes to performance explanations. Managers have strong incentives to manage outsiders perceptions by explaining corporate nancial results in a way that paints management and the rm in a favorable light. Firms that report positive (negative) nancial results experience larger positive (negative) stock market reactions when investors perceive that the performance will persist in future periods (Collins and Kothari, 1989). Consequently, rm managers, especially those with stock-based compensation, have incentives to provide disclosures that point to permanent factors when performance is good and to temporary factors when performance is poor. Managers also have incentives to attribute good performance to internal factors and poor performance to external factors. Such explanations allow managers to take credit for good results and shift blame for poor results, and thus should increase analysts and investors beliefs about managements ability to generate positive abnormal returns. In addition, the board of directors may use managements performance explanations when evaluating managements performance. If the board believes management is responsible for good performance, but not responsible for poor performance, this should have positive effects on the managers pay and job security.3 In sum, managers have incentives to provide self-serving disclosures that attribute good nancial performance to permanent internal factors and poor performance to temporary external factors. Empirical evidence conrms that managements performance explanations tend to be self-serving. Bettman and Weitz (1983) and Staw et al. (1983) analyze performance explanations provided in letters to shareholders and nd that managers are more likely to attribute good performance to internal factors such as visionary leadership and effective cost management. Poor performance, in contrast, tends to be attributed to temporary external factors such as supplier problems, the weather, and natural disasters. Baginski et al. (2000, 2004) report a similar pattern in explanations accompanying managements earnings forecasts.
2 The game theory literature denes disclosures that are costless, nonbinding and nonveriable as cheap talk (Farrell and Rabin, 1996, p. 116). 3 Indeed, as we discuss more fully in Section 5, management may obtain positive effects from these types of self-serving disclosures even if the board of directors does not believe them. Empirical evidence shows only a weak link between rm performance and CEO turnover (Brickley, 2003), suggesting that boards of directors avoid disciplining underperforming managers. If board members are reluctant to punish managers, they may rely on managements self-serving performance explanations even when the explanations are implausible, because doing so provides them with an excuse to avoid disciplining managers.

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Despite these disclosure tendencies, nancial analysts appear to use managements performance explanations when assessing rms prospects. Analysts surveyed by Clarkson et al. (1999) indicated that MD&A disclosures contain useful, high-quality information. A recent survey conducted by the Association of Investment Management and Research supports this view86% of surveyed nancial analysts indicated that managements discussion of corporate performance was an extremely or very important factor in assessing rm value (AIMR, 2000). Moreover, Rogers and Grant (1997) nd that analysts research reports rely more on explanations included in MD&As than any other single source. At rst blush, this reliance seems surprising. If managers explanations for rm performance are self-serving cheap talk, then why do analysts rely so heavily on these explanations? One possibility is that models assuming that analysts disregard self-serving performance explanations are overly simplistic. An extensive literature on persuasion shows that even costless messages sometimes convey information effectively (e.g., Eagly and Chaiken, 1993; Forsythe et al., 1999). Although analysts may be skeptical of disclosures that are consistent with managements incentives (Eagly et al., 1978; Birnbaum and Stegner, 1979), this does not necessarily imply that the disclosures will be ignored. Rather, analysts skepticism may lead them to engage in additional cognitive processing to determine whether the disclosures should be relied upon (Hutton et al., 2003). For example, suppose an apparel retailer reports a decrease in sales and attributes it to unusually warm weather conditions over the past year. This explanation is certainly self-serving as it blames the rms poor performance on a temporary external factor. Consequently, analysts will likely use other cues such as the actual weather conditions over the past year and the percentage of revenues typically derived from winter apparel to assess the plausibility of managements explanation. We predict that nancial analysts reactions to managements self-serving performance explanations will depend critically on the explanations plausibility. We test this prediction by examining how analysts react to explanations that blame poor performance on temporary external factors but vary in plausibility. We focus on temporary external explanations for poor performance rather than permanent internal explanations for good performance for two reasons. First, external explanations for poor performance are more prevalent (Bettman and Weitz, 1983; Staw et al., 1983; Baginski et al., 2000, 2004). Second, research shows that people spend more time thinking about bad outcomes than good outcomes (Wong and Weiner, 1981). This research suggests that analysts will think more about the reasons for poor corporate performance, leading to deeper analysis of managements explanations and thus greater variability in the perceived plausibility of explanations for poor performance. In the remainder of this section, we develop specic hypotheses about the effects of these explanations. Performance explanations that attribute poor performance to temporary external factors suggest that the poor performance is unlikely to persist in future periods. Thus, when analysts nd such explanations to be plausible, they are less likely to believe that the poor performance will persist than if the explanation had not been provided. These beliefs about earnings persistence will be reected in analysts

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earnings forecasts, resulting in higher earnings forecasts for rms that provide such explanations. The literature is less clear about the effects of implausible explanations. Most theoretical models suggest that analysts will simply disregard implausible explanations. For example, cheap talk models often include babbling equilibria, where the discloser sends uninformative messages that are ignored by the receiver (Farrell and Rabin, 1996; Crawford, 1998). Similarly, most belief-updating models in psychology assume that when message receivers update their beliefs, they give zero weight to implausible messages (Shanteau, 1970; Anderson, 1981; Hogarth and Einhorn, 1992). These models imply that analysts who deem a performance explanation to be implausible will simply ignore the explanation and rely on their own beliefs about the reasons for the rms performance. If this occurs, implausible explanations will have no effect on analysts beliefs about the persistence of the rms performance, and thus no effect on analysts earnings forecasts. However, recent research contradicts these earlier models. McKenzie et al. (2002) propose a belief-updating model where weak evidence supporting an argument can backre and move beliefs in the opposite direction. The authors nd strong support for the validity of this model in a series of legal judgment experiments. They show that when jurors receive weak evidence from either the prosecution or defense, their beliefs in favor of the other sides case grow stronger. Jurors who receive weak evidence apparently think, If thats the best you can come up with, then the opposite must be true. If analysts behave similarly, implausible explanations that blame poor performance on temporary external factors (which managers offer to suggest that the performance will not persist) may backre and actually increase analysts beliefs about the persistence of the poor performance. Under this scenario, implausible explanations will result in lower earnings forecasts than if no explanation had been provided. In sum, we predict that plausible explanations that blame poor performance on temporary external factors will increase analysts earnings forecasts. Implausible explanations, in contrast, are expected to lead to negative inferences about the rms prospects and lower earnings forecasts. These predictions are summarized in the following hypotheses: Hypothesis 1a. Plausible (implausible) explanations that blame poor performance on temporary external factors will decrease (increase) analysts beliefs that the poor performance will persist. Hypothesis 1b. Plausible (implausible) explanations that blame poor performance on temporary external factors will increase (decrease) analysts earnings forecasts. These earnings forecast effects should ow through to analysts stock valuations. However, we expect explanation plausibility to affect analysts valuations in another way as well. Specically, we predict that the plausibility of managements performance explanations will affect managements reputation, and these changes in reputation, in turn, will inuence analysts assessments of the rms cost of capital. We develop these ideas more fully below.

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Prior research suggests that the quality of managements disclosures affects how management is viewed by analysts and investors (Williams, 1996; Mercer, 2005). Analysts are especially likely to make inferences about management based on its voluntary disclosures because management has greater exibility in these disclosures (cf. Jones and Davis, 1965). Although managers are required to provide performance explanations in their MD&A, they have considerable exibility about the type and depth of explanations they provide (Bryan, 1997). Consequently, managements performance explanations are a potentially important determinant of its reputation with analysts and investors. Managements reputation affects its ability to credibly communicate information to the capital markets (Williams, 1996). Credible communication is important because theoretical models suggest that rms with less credible public information will experience lower stock liquidity and higher estimation risk (Barry and Brown, 1985; Amihud and Mendelson, 1986; OHara, 2003). In a simple CAPM world, rmspecic information risk would not be priced. However, recent empirical evidence suggests that information risk is not fully diversiable and thus is priced as part of the rms cost of capital (Botosan, 1997; Easley et al., 2002; Francis et al., 2004, 2005). Both anecdotal and academic evidence support the idea that managements disclosures affect its reputation and that changes in reputation in turn affect the rms cost of capital. For instance, Wall Street analysts claim that rms trade at a liars discount (i.e., a lower price-to-earnings ratio than industry peers) after providing misleading disclosures (King, 1998). Academic studies show that rms subject to SEC enforcement actions experience signicant increases in their cost of capital (Dechow et al., 1996), and rms with sustained increases in disclosure quality experience positive stock price effects (Healy et al., 1999). Dechow et al. (1996) and Healy et al. (1999) argue that the market consequences they document are driven, at least in part, by the effects of disclosure quality on managements reputation. Based on this discussion, we predict that plausible explanations blaming poor performance on temporary external factors will improve managements reputation, leading to a lower cost of capital than if the explanation had not been provided. Implausible explanations, in contrast, are expected to harm managements reputation and thus increase the rms cost of capital. Hypothesis 2a. Plausible (implausible) performance explanations will improve (harm) managements reputation with analysts. Hypothesis 2b. Plausible (implausible) performance explanations will decrease (increase) analysts estimates of the rms cost of capital.

3. Method We test our hypotheses by conducting an experiment via mail with 124 nancial analysts. We recruited the analysts using a business school alumni database and

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randomly assigned them to one of three conditionsPlausible, Implausible, or Control.4 To be eligible for our study, participants were required to be experienced at evaluating managements performance explanations. Participants averaged 6.2 years of work experience in nancial analysis and 66.1% held an MBA degree. All participants received information about Sutte, Inc., a ctitious company that owns and operates restaurants in Turkey. Participants rst received background information about the company, including a brief description of the companys business and a map with the locations of its restaurants (see Fig. 2). In addition, participants viewed three years of historical income statement information. The income statements showed that the companys nancial performance in the most recent year was materially worse than its historical performance. Specically, earnings per share in the most recent year was $1.03, compared to $1.91 and $1.88 for the two prior years. After reviewing the background information, participants in the Plausible and Implausible conditions received explanations for the companys recent poor performance. Those in the Plausible condition received the following excerpt from the companys MD&A: . . .The unexpected negative results for 1999 are largely due to factors related to a major earthquake in Turkey in the middle of 1999.5 The epicenter of the earthquake was near Kocaeli (in the far northwest region, near Istanbul) and tremors could be felt up to 150 miles away. No Sutte restaurant was damaged in the earthquake. However, Sutte restaurants near the epicenter were closed for several weeks following the earthquake. In addition, there was a decrease in consumer demand for fast food in areas near the epicenter (i.e., within 150 miles) for several months thereafter. . . This paragraph, in combination with the map in Fig. 2, provides a plausible explanation for Suttes poor performance over the past year. The map shows that most of Suttes stores are located in the northwest corner of the country where the earthquake was centered. Participants in the Implausible condition received an identical disclosure, except they were told that the earthquake was near Van (in the far southeast region)
We initially contacted nancial analyst alumni by email and asked them whether they would be willing to participate and to recruit other analysts at their rm. If an alumnus/a agreed to participate, we mailed him or her 11 sets of experimental materials (all materials were randomized before mailing). Each alumnus/a then recruited up to ten other analysts at his or her rm to participate in the study, collected the completed experimental materials, and returned the materials to us using an envelope we provided. Of the 26 alumni who agreed to participate, 20 (77%) returned at least one set of completed experimental materials. The alumni who agreed to participate were employed at 16 different rms, and the mean number of sets of experimental materials returned per alumnus/a was six. 5 We conducted the experiment in 20022003. Turkey is well-known as an earthquake region, and has had several highly publicized earthquakes in the last decade. Consequently, we believed that participants would nd a 1999 earthquake in Turkey to be plausible. However, we expected that participants would not remember the exact locations of historical earthquakes in Turkey, and thus would regard earthquakes in the two cities as equally plausible. This expectation is supported by a review of participants responses; none questioned the occurrence of an earthquake at either location.
4

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instead of near Kocaeli (in the far northwest region, near Istanbul). Because the map shows that most of Suttes stores are in the northwest corner of the country far from an earthquake in Vanthis earthquake is an implausible explanation for Suttes poor performance.6 Participants in the Control condition did not receive an explanation for the rms nancial performance. The Control condition provides a benchmark for comparison when examining the effects of the performance explanations on analysts judgments. After reading the background information and performance explanation (if provided), analysts answered a series of questions about the rms prospects and its management. To capture analysts performance expectations, we asked them to assess the persistence of the rms recent poor performance and to forecast earnings per share for the following year. To elicit the rms cost of capital, we informed analysts that the rms trailing price-to-earnings ratio ranged between 9 and 12 in the prior year and asked them to estimate the current per share stock value. We then divided each analysts valuation by his or her earning per share forecast. We use the
There are numerous ways to manipulate explanation plausibility. For example, we could have provided participants with external explanations for poor performance and varied either the rms industry or the type of external event across conditions. However, these manipulations would have altered the information provided to participants as well as the plausibility of the explanation. Our approach allows us to vary explanation plausibility while holding constant all other information about the rm and its prospects.
6

,
Fig. 2. Excerpt from experimental materials.

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resulting earnings valuation multiples to proxy for analysts beliefs about the rms cost of capital.7 To measure managements reputation, we asked analysts to assess how competent and truthful management is in its nancial reporting.8 Finally, analysts answered a series of manipulation check and demographic information questions.

4. Results 4.1. Manipulation check At the end of the study, participants rated the plausibility of managements performance explanation on a 7-point scale (1 Not at all plausible to 7 Extremely plausible). Participants in the Plausible condition rated managements explanation as signicantly more plausible mean 4:75 than those in the Implausible condition mean 1:82 (t 10:40, one-tailed po0:01), suggesting that our plausibility manipulation was successful. 4.2. Hypothesis tests Hypotheses 1a and 1b predict that analysts in the Plausible (Implausible) condition will be less (more) likely to believe that the poor performance will persist and forecast higher (lower) earnings than analysts in the Control condition. We test these hypotheses using the following regression models: PERSISTENCE a0 a1 PLAUSIBLE a2 IMPLAUSIBLE 1 , EPS FORECAST b0 b1 PLAUSIBLE b2 IMPLAUSIBLE 2 , (1) (2)

where PERSISTENCE reects the analysts belief about the persistence of the rms poor performance, measured on a 7-point scale (1 Not at all likely to persist to 7 Very likely to persist); EPS FORECAST is the analysts forecast of next years earnings per share; PLAUSIBLE is an indicator coded 1 if the analyst is in the Plausible condition (0 otherwise); and IMPLAUSIBLE is an indicator coded 1 if the analyst is in the Implausible condition (0 otherwise). In statistical terms, Hypothesis 1a predicts a1 o0 and a2 40, and Hypothesis 1b predicts b1 40 and b2 o0. The
All else equal, price-to-earnings ratios are increasing in earnings persistence and decreasing in the cost of capital. A path analysis reported in Section 4.3 suggests that analysts beliefs about the persistence of the rms performance were not a signicant factor in their earnings multiples. Management reputation, in contrast, was an important determinant of analysts multiples. These results suggest that variation in analysts beliefs about the rms cost of capital, rather than variation in their beliefs about the rms earnings persistence or growth opportunities, are driving analysts earnings multiples in our study. Consequently, we use analysts earnings multiples as a proxy for the rms cost of capital. 8 The management reputation questions were drawn from validated source credibility scales. These scales identify two primary dimensions underlying managements reporting credibility: competence and trustworthiness (cf. Gifn, 1967; Mercer, 2005).
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Table 1 Effects of explanation plausibility on perceived persistence of poor performance and earnings per share forecasts Panel A: Descriptive statistics PERSISTENCE Condition n Mean Standard deviation 1.25 1.32 1.24

EPS FORECAST n Mean Standard deviation 0.21 0.26 0.36

Control Plausible Implausible

45 36 43

4.02 3.41 4.93

45 36 43

1.56 1.73 1.38

Panel B: Regression results for PERSISTENCE a0 a1 PLAUSIBLE a2 IMPLAUSIBLE  Independent variable Expected Coefcient t-Statistic sign Intercept PLAUSIBLE IMPLAUSIBLE R2 Model F -statistic 4.02 0.61 0.91 0.19 14.46 21.30 2.15 3.36

Panel C: Regression results for EPS FORECAST b0 b1 PLAUSIBLE b IMPLAUSIBLE  Independent variable Expected Coefcient t-Statistic sign Intercept PLAUSIBLE IMPLAUSIBLE R2 Model F -statistic

1.56 0.17 0.18 0.19 14.11

36.76 2.60 2.89

and denote signicance at the 0.01 and 0.05 levels, based on one-tailed tests for signed predictions and two-tailed tests otherwise. PERSISTENCE is the participants rating of the persistence of the rms poor nancial performance, on a 7-point scale (1 Not at all likely to persist to 7 Very likely to persist). EPS FORECAST is the participants forecast of next years earnings per share. PLAUSIBLE is an indicator coded 1 if the participant received a Plausible external explanation for the rms poor performance and 0 otherwise. IMPLAUSIBLE is an indicator coded 1 if the participant received an Implausible external explanation for the rms poor performance and 0 otherwise.

intercepts a0 and b0 capture the mean levels of perceived PERSISTENCE and EPS FORECAST for analysts in the Control condition. Table 1 presents descriptive statistics and regression results for Eqs. (1) and (2).9 Regarding Eq. (1), Panel A shows that analysts in the Plausible condition believe that the poor performance is less likely to persist mean 3:41 than analysts in the Control condition mean 4:02. Implausible explanations have the opposite
9 Our regressions are based on ordinary least-squares estimation and test for signicant differences in the means of the dependent variables across conditions. In untabulated analyses, we nd qualitatively similar results using quantile regressions to test for differences in medians.

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effectanalysts in the Implausible condition believe that the poor performance is more likely to persist mean 4:93 than analysts in the Control condition mean 4:02. The regression results reported in Panel B show that these differences are statistically signicant. Specically, in support of Hypothesis 1a, we observe a negative coefcient on PLAUSIBLE (a1 0:61, t 2:15, one-tailed p 0:02) and a positive coefcient on IMPLAUSIBLE (a2 0:91, t 3:36, one-tailed po0:01). Regarding Eq. (2), Panel A shows that analysts in the Plausible condition reported a mean EPS FORECAST of $1.73, compared with $1.56 in the Control condition. Regression results in Panel C show that this difference is signicant (b1 0:17, t 2:60, one-tailed po0:01). In contrast, analysts in the Implausible condition reported a mean EPS FORECAST of $1.38, signicantly lower than those in the Control condition (b2 0:18, t 2:89, one-tailed po0:01). These results support Hypothesis 1b. Given these effects on analysts earnings forecasts, we expect a similar pattern in analysts stock valuations. We examine analysts valuations using the following regression model: VALUE f0 f1 PLAUSIBLE f2 IMPLAUSIBLE 3 , (3)

where VALUE is the analysts estimate of the rms stock value, and PLAUSIBLE and IMPLAUSIBLE are as previously dened. Untabulated analyses show mean VALUE assessments of $14.49 per share in the Control condition, $16.35 per share in the Plausible condition, and $11.56 per share in the Implausible condition. Consistent with expectations, analysts assessed signicantly higher stock values when they received a plausible explanation (f1 1:86, t 2:23, one-tailed p 0:02) and signicantly lower stock values when they received an implausible explanation (f2 2:93, t 3:64, one-tailed po0:01). This pattern in analysts stock valuations could be driven solely by analysts earnings forecasts. However, there is another possibilitymanagements explanations also could affect analysts stock valuations through their effects on managements reputation and the rms cost of capital. Recall that Hypothesis 2a predicts that plausible (implausible) performance explanations will improve (harm) managements reputation, and Hypothesis 2b predicts that these reputation effects will be reected in analysts assessments of the rms cost of capital. We test these hypotheses using the following regression models: REPUTATION g0 g1 PLAUSIBLE g2 IMPLAUSIBLE 4 , MULTIPLE d0 d1 PLAUSIBLE d2 IMPLAUSIBLE 5 , (4) (5)

where REPUTATION is an equally weighted average of analysts assessments of managements competence and truthfulness,10 MULTIPLE is each analysts
Analysts indicated their agreement with statements about whether rm management is competent and truthful on 7-point scales (1 Strongly Disagree to 7 Strongly Agree). Analysts responses to the two statements are highly correlated (Pearson correlation 0:70; Cronbachs alpha 0:83), suggesting that they capture a common underlying construct. Principal component and factor analyses on
10

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VALUE judgment divided by his or her EPS FORECAST, and PLAUSIBLE and IMPLAUSIBLE are as previously dened. Hypothesis 2a predicts g1 40 and g2 o0, and Hypothesis 2b predicts d1 40 and d2 o0. Table 2 presents descriptive statistics and regression results for Eqs. (4) and (5). Panel A shows mean management REPUTATION of 3.86 in the Control condition, 4.03 in the Plausible condition, and 2.53 in the Implausible condition. The regression results in Panel B provide partial support for Hypothesis 2a. Specically, the coefcient on IMPLAUSIBLE is negative as predicted (g2 1:33, t 7:59, onetailed po0:01), but the coefcient on PLAUSIBLE is not signicant (g1 0:17, t 0:94, one-tailed p 0:17). In other words, providing implausible explanations appears to have negative effects on managements reputation, but providing plausible explanations does not positively inuence managements reputation. One possible reason for this asymmetric result is that analysts expect managers to provide plausible explanations for their rms results and therefore do not reward managers who meet this expectation. Given these reputation effects, we should see a similar pattern in analysts earnings valuation multiples. Panel A of Table 2 shows that analysts apply a mean MULTIPLE of 9.23 in the Control condition, 9.40 in the Plausible condition, and 8.46 in the Implausible condition. Consistent with the REPUTATION results, Panel C shows that the regression coefcient on IMPLAUSIBLE is signicantly negative (d2 0:77, t 1:88, one-tailed p 0:03), but the coefcient on PLAUSIBLE is insignicant (g1 0:17, t 0:41, one-tailed p 0:34). Thus, analysts who received an implausible explanation applied a lower earnings multiple than analysts in the Control condition, but plausible explanations did not affect analysts earnings multiples. In sum, we nd support for the notion that managers performance explanations inuence analysts beliefs about the rm and its management, though not always in the direction intended by managers. Specically, we nd that when analysts receive a plausible explanation blaming poor performance on temporary external factors, they are less likely to think that the poor performance will persist and thus provide higher earnings forecasts and stock valuations. However, if analysts nd such explanations to be implausible, they make negative inferences that lead to lower earnings forecasts, a higher cost of capital, and lower stock valuations. 4.3. Path analysis An important benet of experimental research is the ability to collect process data to help determine why effects occur (Libby et al., 2002). We predicted that managements performance explanations would affect analysts stock valuations in
(footnote continued) these questions retain one factor that explains 85% of the variance in analysts responses. These untabulated analyses also show nearly identical loadings and scoring coefcients for the two questions, suggesting that we do not lose information using an equally weighted mean to measure managements reputation.

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Table 2 Effects of explanation plausibility on management reputation and earnings valuation multiples Panel A: Descriptive statistics REPUTATION Condition n Mean Standard deviation 0.56 0.88 0.99

MULTIPLE n Mean Standard deviation 1.90 1.52 2.13

Control Plausible Implausible

45 36 43

3.86 4.03 2.53

44 36 41

9.23 9.40 8.46

Panel B: Regression results for REPUTATION g0 g1 PLAUSIBLE g2 IMPLAUSIBLE  Independent variable Expected Coefcient t-Statistic sign Intercept PLAUSIBLE IMPLAUSIBLE R2 Model F -statistic 3.86 0.17 1.33 0.41 41:60 31:47 0.94 7:59

Panel C: Regression results for MULTIPLE d0 d1 PLAUSIBLE d IMPLAUSIBLE  Independent variable Expected Coefcient t-Statistic sign Intercept PLAUSIBLE IMPLAUSIBLE R2 Model F -statistic
,

9.23 0.17 0:77 0.05 2:83

32:61 0.41 1:88

and denote signicance at the 0.01, 0.05 and 0.10 levels, based on one-tailed tests for signed predictions and two-tailed tests otherwise. REPUTATION is an equally weighted average of the participants agreement with statements about whether management is competent and truthful, each measured on a 7-point scale (1 Strongly disagree to 7 Strongly agree). MULTIPLE is the participants estimate of the rms per share stock value divided by his or her earnings per share forecast. PLAUSIBLE is an indicator coded 1 if the participant received a Plausible external explanation for the rms poor performance and 0 otherwise. IMPLAUSIBLE is an indicator coded 1 if the participant received an Implausible external explanation for the rms poor performance and 0 otherwise.

two ways: (1) by affecting analysts beliefs about the persistence of the performance and, in turn, their earnings forecasts; and (2) by affecting analysts beliefs about management and, in turn, their assessments of the rms cost of capital. In the previous section, we examined the effects of managements performance explanations on analysts beliefs about earnings persistence, management reputation, future earnings, and the cost of capital. These analyses provided insight into the role that managements explanations play in each step of the process but did not provide an overall test of this process. In this section, we conduct a path analysis to test the overall process, as well as the specic paths by which managements explanations

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affect stock value. Path analysis is an application of multiple regression analysis that tests the direct and indirect relations among a set of variables.11 Path analysis represents these relations using a series of structural equations, which are typically depicted in a diagram to allow for a clearer conceptualization of the causal links. In our path analysis, PLAUSIBILITY is an indicator coded 1 for analysts in the Plausible condition, 0 for analysts in the Control condition, and 1 for analysts in the Implausible condition. The remaining variables are dened as before. To test the model, we regress each variable on all variables preceding it in the model (see Panel A of Fig. 3). For example, EPS FORECAST is regressed on PLAUSIBILITY, PERSISTENCE, and REPUTATION. All regressions are estimated jointly using maximum likelihood techniques.12 The resulting standardized coefcients are compared with the observed correlation matrix for the variables and a goodnessof-t statistic is calculated. This analysis suggests that our model ts the data well. The comparative t index is 0.97 for the model; values greater than 0.90 indicate a good t (Kline, 1998, p. 131). Panel B of Fig. 3 reports the standardized partial regression coefcients (i.e., path coefcients) for all links that are signicant at the 0.10 level. We nd that all of our predicted links are statistically signicant. Specically, the PLAUSIBILITY ! PERSISTENCE link is negative (coefficient 0:44, one-tailed po0:01) and the PLAUSIBILITY ! REPUTATION link is positive (coefficient 0:58, one-tailed po0:01), consistent with our earlier results. The PERSISTENCE ! EPS FORECAST link is negative (coefficient 0:39, one-tailed po0:01), conrming that analysts who believe that the poor performance is likely to persist tend to forecast lower earnings. The REPUTATION ! MULTIPLE link is positive (coefficient 0:21, one-tailed p 0:03), suggesting that analysts who believe that management is more reputable tend to use higher earnings valuation multiples (i.e., assign a lower cost of capital). Finally, both the EPS FORECAST!VALUE and MULTIPLE!VALUE links are positive (coefficients 0:66 and 0.69, respectively; each with one-tailed po0:01). Importantly, after controlling for these mediating variables, the PLAUSIBILITY!VALUE link is no longer statistically signicant (coefficient 0:01, one-tailed p 0:22). Thus, consistent with our theoretical predictions, explanation plausibility affects analysts stock valuations through their beliefs about earnings persistence and managements reputation. Our analysis shows one unexpected link: PLAUSIBILITY!EPS FORECAST. This signicant link suggests that PERSISTENCE did not fully mediate the effect of explanation plausibility on analysts earnings per share forecasts. However,
11 Path analysis is referred to as structural equation modeling when the variables in the model are latent and measured with multiple observed variables using factor analysis. See Kline (1998) for a discussion of path analysis and structural equation modeling. 12 Our model is essentially a diagonally recursive simultaneous equations model (i.e., no variable affects and depends at the same time on another variable or feeds back to itself through other variables). Consequently, the model also could be estimated using ordinary least squares. We use maximum likelihood because it takes into account potential correlations among disturbances across equations and tends to be robust to misspecication and nonnormality (Olsson et al., 2000). However, untabulated results using ordinary least squares are similar.

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PERSISTENCE

EPS FORECAST

PLAUSIBILITY

VALUE

REPUTATION (A)

MULTIPLE

0.39***

PERSISTENCE
0.44***

EPS FORECAST
0.66***

0.22**

PLAUSIBILITY

VALUE

0.58***

0.69***

REPUTATION (B)
0.21**

MULTIPLE

Fig. 3. Path analysis. Panel A depicts the path model, where the arrows indicate links that are tested and the solid arrows indicate links that are predicted to be signicant. Panel B reports standardized path coefcients for all links signicant at the 0.10 level or better. Specically, and denote signicance at the 0.01 and 0.05 levels, based on one-tailed tests for signed predictions and two-tailed tests otherwise. PLAUSIBILITY is an indicator coded 1 for analysts in the Plausible condition, 0 for analysts in the Control condition, and 1 for analysts in the Implausible condition. PERSISTENCE is the participants rating of the persistence of the rms poor nancial performance, on a 7-point scale (1 Not at all likely to persist to 7 Very likely to persist). REPUTATION is an equally weighted average of the participants agreement with statements about whether management is competent and truthful, each measured on a 7-point scale (1 Strongly disagree to 7 Strongly agree). EPS FORECAST is the participants forecast of next years earnings per share. MULTIPLE is the participants estimate of the rms per share stock value divided by his or her earnings per share forecast. VALUE is the participants estimate of the rms per share stock value.

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follow-up tests show that it does partially mediate the effect (z 3:62, two-tailed po0:01).13 The likely reason for this partial, rather than full, mediation is noise in the PERSISTENCE measure. Such effects are common in experimental research and, as such, partial mediation is generally considered supportive of a mediation hypothesis (Kenny et al., 1998). 4.4. Additional analyses To ensure that analysts responses were not driven by them guessing our experimental manipulations, we asked analysts to provide earnings forecasts and valuation judgments before answering the management reputation and manipulation check questions. However, it is possible that some analysts answered the questions out of sequence or changed their forecasts and valuations after viewing the later questions. In response, we performed two tests to determine whether answering the management reputation and manipulation check questions at the end of the experimental materials inuenced analysts earnings forecasts and valuations. First, we examined the completed surveys to identify analysts who appeared to go back and change their responses to the earnings forecast and valuation questions. Specically, we looked for responses that had been crossed out (if the analyst used pen) or erased and rewritten (if the analyst used pencil). This analysis revealed only ve analysts who altered their earnings forecast and stock valuation judgments, suggesting that most analysts did not go back and change their assessments after answering the later questions. Removing these ve analysts from the analyses does not materially affect the results. Nevertheless, the management reputation and manipulation check questions still could have impacted earnings forecasts and stock valuations if analysts read through all the questions before answering any of them. To test the plausibility of this explanation for our pattern of results, we conducted a follow-up experiment with 149 second-year MBA students. We used second-year MBA students to test this methodological point because we expect them to have the requisite knowledge about managements disclosure incentives and because we were able to place them in a monitored laboratory environment. Our MBA participants averaged 4.5 years of work experience and had taken an average of six nance and accounting courses.
13 PERSISTENCE is considered to mediate the relation between EPS FORECAST and PLAUSIBILITY if: (1) PLAUSIBILITY signicantly affects PERSISTENCE, (2) PLAUSIBILITY signicantly affects EPS FORECAST in the absence of PERSISTENCE, (3) PERSISTENCE has a signicant unique effect on EPS FORECAST, and (4) the effect of PLAUSIBILITY on EPS FORECAST is signicantly reduced when the effect of PERSISTENCE is controlled (Baron and Kenny, 1986). We formally assess the signicance of PERSISTENCE as a partial mediator of the relation between PLAUSIBILITY and EPS FORECAST using the following test statistic: ab=sqrta2 s2 b2 s2 s2 s2 , where a and sa are the a a b b coefcient and its standard error from a regression of PERSISTENCE on PLAUSIBILITY, and b and sb are the coefcient of PERSISTENCE and its standard error in a regression of EPS FORECAST on PLAUSIBILITY and PERSISTENCE. The p-value of the test is drawn from a unit normal distribution under the null hypothesis that the mediated or indirect effect of PLAUSIBILITY on EPS FORECAST (i.e., the ab product) equals zero in the population (Goodman, 1960; Sobel, 1982; Baron and Kenny, 1986).

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The follow-up experiment used the same three-cell design as our initial study, but varied the questions answered between participants. Specically, half of the participants provided earnings forecasts and stock valuations but did not answer the management reputation or manipulation check questions. The remaining half answered only the reputation and manipulation check questions. Participants who provided earnings forecasts and stock valuations show response patterns identical to those in the initial experiment. Specically, earnings forecasts in the Plausible condition are signicantly higher (t 2:93, one-tailed po0:01) and earnings forecast in the Implausible condition are signicantly lower (t 2:12, onetailed p 0:02) than those in the Control condition. Also similar to our initial experiment, participants in the Implausible condition use a lower earnings multiple than those in the Control condition (t 1:57, one-tailed p 0:06), but the earning multiples used in the Plausible and Control conditions do not differ signicantly (t 0:26, one-tailed p 0:39). Participants who answered the reputation questions also show a similar pattern of responses to those in the initial experiment. Specically, managements reputation is signicantly lower in the Implausible condition than in the Control condition (t 3:06, one-tailed po0:01), but does not differ between the Plausible and Control conditions (t 0:67, one-tailed p 0:25). The fact that we observe similar patterns of results in our initial and follow-up studies provides additional comfort that answering the reputation and manipulation check questions did not drive the observed pattern in analysts earnings forecasts and stock valuations. Further, the follow-up study suggests that the effects identied in our initial study are generalizable, applying to both more and less sophisticated investors.

5. Conclusions We nd that managers attempts to blame poor performance on temporary external factors inuence nancial analysts interpretations of the rms results. Specically, when analysts believe such explanations, they are more optimistic about the rms prospects and thus provide higher earnings forecasts. However, when analysts do not believe managers explanations, such disclosures cause analysts to make negative inferences about the rms prospects, resulting in more pessimistic earnings forecasts than if the explanation had not been provided. These effects on analysts earnings forecasts ow through to their stock valuations. Moreover, our analyses indicate that this is not the only path by which performance explanations affect rm value. These explanations also affect managements reputation which, in turn, affects the rms cost of capital. Unfortunately for managers who seek to improve their reputations by providing credible explanations for their performance failures, these reputational consequences are not symmetric. That is, when analysts nd management performance explanations to be implausible, managements reputation is damaged in the eyes of analysts, but when management provides plausible performance explanations, analysts do not reward management with an improved reputation.

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On a practical level, our results provide guidance to managers about how nancial analysts react to their performance explanations. We nd that blaming poor performance on temporary external factors can be a risky strategy. If analysts deem such explanations implausible, they do not simply ignore the explanations. Rather, they make negative inferences about both the rms future prospects and its management. Thus, our results underscore the importance of gauging the plausibility of performance explanations for poor performance before they are released to analysts. In addition, because we document not just the effects of implausible explanations but also why such effects occur, our results should be helpful to managers who inadvertently provide implausible explanations. Implausible explanations have negative effects on analysts beliefs about both the persistence of the poor performance and managements reputation. Thus, our results imply that any subsequent efforts at damage control related to these implausible explanations should focus on convincing analysts that the poor performance will not persist and bolstering managements reporting reputation. Our results also have implications for researchers. Prior studies show that managers tend to blame poor performance on temporary external factors (Bettman and Weitz, 1983; Staw et al., 1983; Baginski et al., 2000). We extend this literature by examining how nancial analysts respond to such explanations. We nd that analysts use managements performance explanations to make inferences about both the persistence of the rms performance and managements reputation. Our results suggest that archival studies on the effects of managements performance explanations should consider both the short- and long-term consequences of these disclosures because, while analysts revise their beliefs about persistence once the next periods results are disclosed, reputation effects are likely more long lived (Slovic, 1993). Further, because analysts reactions depend critically on explanation plausibility, our results suggest the importance of conditioning on this variable when examining market reactions to managements performance explanations. The studys theoretical underpinnings may be of interest to researchers in related areas as well. We test our theoretical framework by investigating nancial analysts reactions to performance explanations. However, our predictions should generalize to within-rm performance explanations, such as those that divisional managers provide to senior management. Moreover, our framework may help explain why the capital market reacts so negatively when a rm misses its earnings target by a small amount (e.g., Barton and Simko, 2002; Skinner and Sloan, 2002). Analysts who receive implausible performance explanations from management apparently think If thats the best you can come up with, things must be especially bad and react by providing lower stock valuations. If market participants react in a similar fashion when they observe rms that miss earnings by a small amount (i.e., if they think that conditions must be particularly bad if the rm cannot come up with an extra penny of earnings), this could explain the large negative reactions to small earnings misses. Our results suggest several areas for future research. For example, additional research is needed to understand why managers provide implausible explanations blaming poor performance on temporary external factors. There are several potential reasons why managers might continue to provide implausible explanations

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despite their negative consequences. One possibility is that managers believe their own spin. Self-serving attributions arise, in part, because people want to believe that they are competent (Miller, 1976; Forsyth, 1980). Thus, managers may make these performance attributions as an ego-saving device, deluding themselves into believing that poor performance is due to factors out of their control. If managers believe their own self-serving explanations, they may nd it difcult to anticipate when analysts and investors will nd these explanations implausible (Ross et al., 1977). A second possibility is that managers recognize when their explanations are implausible but do not realize that these disclosures have negative consequences. When a rm reports unexpected poor performance, market participants typically react negatively regardless of the plausibility of the associated explanation. Consequently, it may be difcult for managers to detect that the market reacts more negatively to implausible explanations. If managers do not receive useful feedback on their disclosure choices, they cannot learn from their mistakes (Einhorn, 1982). A third possibility is that managers are aware that implausible explanations have negative market consequences but continue to provide them because these disclosures positively affect managements relationship with its board of directors. Prior research suggests that boards of directors are loath to discipline underperforming managers. For example, moving from the top performance decile to the bottom performance decile increases the probability of CEO turnover by only 4% (Brickley, 2003). Board members, especially if they are not independent, may lack sufciently strong incentives to punish management. In that case, they may be willing to accept even implausible performance explanations when doing so allows them to avoid disciplining managers. Future research may wish to consider the impact of different types of management disclosures on managements relationship with its board of directors. Given the importance of explanation plausibility on analysts stock valuations, future studies also may wish to examine the factors that analysts use to assess an explanations plausibility. In our study, analysts assessed the plausibility of managements explanations by thinking about whether an earthquake in a particular location could explain a rms poor nancial performance. In other cases, the process by which analysts assess an explanations plausibility may be more complex (e.g., multiple cues, dependencies, combination rules). Future research examining the cues that analysts use to evaluate managements explanations and how these cues are combined to arrive at an overall determination of an explanations plausibility will further our understanding of analysts reactions to management disclosures. Finally, researchers may wish to consider the inuence of other types of performance explanations on analysts judgments. Our study examines analysts judgments in a setting where management blames poor performance on a temporary external eventan earthquake. External attributions to temporary events (e.g., weather, re, terrorist incident) are common (Morgenson, 2004). However, managers sometimes blame poor performance on external factors that are likely to persist (e.g., technology shifts, competitor entry, regulatory changes). Other times, managers ignore external factors and attribute poor performance to internal failings.

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Future research that explores how analysts, investors, and boards of directors react to these different types of disclosures will deepen our understanding of the determinants and consequences of managements performance explanations.

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