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This study investigates whether the market rewards (penalizes) firms for meeting (not meeting) analysts' earnings forecasts. Specifically, we examine the market response to positive and negative forecast errors. In addition, we examine whether the sensitivity of stock prices to positive or negative forecast errors is affected by the firms' history of consistently beating or missing analysts' forecasts. The results indicate that the earnings multiple applied to positive unexpected earnings is significantly greater than for negative unexpected earnings. In addition, we find that after controlling for the magnitude of the forecast error and bad news preannouncements, the market penalty for missing forecasts is significantly greater in absolute terms than the response to beating forecasts. We document evidence that, while the market recognizes and partially discounts the systematic component of positive analysts' forecast errors, a higher multiple is attached to the unsystematic component of unexpected earnings of firms that consistently beat analysts' forecasts. Overall, the evidence suggests that the increasing frequency of positive forecast errors as documented in previous research is a rational response by managers to market-related incentives.
Lopez et al. (2002) studied this question.