Long-term Earnings Forecasts, Managerial Distortion, and Stock Returns

We explain stock mispricing linked to long-term expectations of earnings growth in terms of managerial manipulation in high-growth conglomerates. Manipulation does not affect analysts’ forecasts of conglomerate earnings, which are more accurate relative to pseudo-conglomerates. The combined effects of higher return and earning forecastability make high-growth conglomerates with manipulation earn significant alpha of -11% per-annum when accompanied by pessimistic analysts forecast revisions or positive change in investor sentiment. Using SFAS 131 as an experiment, we show that while analysts exploit transparent segment-level information disclosures, mutual funds actively invest in high growth conglomerate with distorted earnings and underperform in the long-run.