ACCOUNTING WORKSHOP “Attracting attention in a limited world: An exploration of the forces behind positive extreme earnings surprises”

Why do large positive earnings surprises occur? The literature often treats large earnings surprises as the exogenous event that precipitates subsequent stock price drift, but analyst expectations and earnings realizations are the result of conscious decisions made by analysts and managers. While neither analysts nor managers have an obvious incentive for an extreme deviation between expected and realized earnings to occur, this phenomenon is regularly observed. In this paper we explore three hypotheses as to why large positive earnings surprises occur: a) managerial manipulation of analyst expectations and/or earnings realizations; b) analyst inattention; and c) natural variation in firm performance. We find support for all three hypotheses. Further, if managers created the earnings surprise to attract attention, they were successful. There is a significant increase in analyst following, the percentage of firm shares held by institutional investors, and short and long-term trading volume following large positive earnings surprises.