Summary 

Managers are under increasing pressure to beat analysts’ earnings estimates, which have personal implications for managerial careers, stock-based pay, and reputations. Analysts’ earnings forecasts represent a critical benchmark that differs from prior return on assets (ROA) aspirations. Boards and corporate managers place heavy emphasis on meeting these earnings forecasts, similar to how they prioritize meeting ROA aspirational goals. Yet, to date, whether and how performance shortfalls in prior ROA vs earnings forecasts differ in their influences remains unclear. This paper, recently published in the Journal of Management Studies, elucidates these differences. 

What is the conundrum? 

In the ever-evolving landscape of business management, understanding how companies respond to performance feedback is crucial for driving strategic change. The common expectation is that when performance falls below aspirations, firms actively seek solutions. While there has been extensive research on internal performance metrics, such as accounting-based ROA, there has been relatively less emphasis on external benchmarks like analysts’ earnings forecasts. These forecasts, issued by financial analysts, serve as crucial benchmarks against which firms are evaluated. Failing to meet these earnings forecasts can lead to significant risks for firms, including a drop in stock prices and challenges in establishing credibility with the financial market. However, we do not have a clear understanding of how accounting-based ROA aspirations differ from analysts’ earnings forecasts in influencing strategic decisions.  

To provide a more comprehensive understanding, the current research distinguished between corporate performance shortfalls based on internal ROA goal versus external earnings forecasts goal and examined the moderating role of business unit (BU) performance using a sample of multiunit firms publicly listed in the information and communication technology (ICT) sector over the period 1998-2016.  

What are the practical implications of the findings? 

Firms increase tendencies to enter new markets in response to performance shortfalls relative to prior ROA but decrease such tendencies in response performance shortfalls relative to earnings forecasts. 

Our findings confirmed that it is crucial to differentiate between shortfalls relative to prior ROA vs earnings forecasts as it sheds light on how managers navigate competing performance goals. Corporate performance shortfalls based on ROA vs earnings forecasts showed diverging influences on new market entry. When firms underperform relative to prior ROA, they search for new product markets to better utilize current resources and mitigate dwindling demand for current products and technologies. Whereas firms facing ROA shortfalls do not automatically lead to an increase in external monitoring, those facing earnings shortfalls are subject to heightened external monitoring and scrutiny by analysts. As a result, they tend to reduce costs to meet analysts’ earnings forecasts, which makes it more challenging to justify investments for entering new markets. Since high costs from market expansions can make actual earnings look worse, the firm’s stock price may be adversely affected along with significant managerial consequences. Underperforming firms are thus less inclined to enter new markets to avoid further earnings erosions while mitigating potential negative impact on market value. 

Higher BU performance weakens the relationships between corporate performance shortfalls (either prior ROA or earnings forecasts) and tendencies to enter new markets. 

The findings also showed the important role of BU performance within the organizational structure. BU performance contributes to overall firm income and serves as a vital source of internal capital for investments. Yet, BU resources arising from BU performance are not limitless. Hence, rather than employing BU financial contributions from higher BU performance to improve shortfalls relative to prior ROA, corporate managers are motivated to divert finite BU resources to improving shortfalls relative to earnings forecasts.  

Corporate managers are inclined “to do something” to send a strong signal to analysts closely monitoring the firm and the financial market that they are taking initiatives to close the earnings performance gap. If new market entry can potentially create firm value, and alternate income streams are available from high-performing BUs, managers that choose to cut costs by reducing new market entry could be penalized by investors and the financial market through a negative market reaction. Hence, corporate managers favor exploring new product avenues in search for solutions to fix corporate earnings shortfall when BU performance is higher. 

Taken together, the research offers vital practical insights for ICT and, more generally, high-tech companies. Firstly, it shows that boards, analysts, investors, and shareholders value both internal and external performance metrics when firms enter new markets. Companies should understand the trade-offs between achieving ROA and meeting earnings forecasts while striving to balance both goals. Understanding the impact of each metric can enhance goal-setting. For instance, focusing on internal ROA goals might lead to strategies for revenue growth in new markets, while emphasizing external earnings forecasts could prioritize efficiency or cost control. Knowing which performance metric drives decisions helps companies optimize strategies and resource allocation. 

Secondly, the findings are crucial for multi-unit companies, where risky initiatives often depend on financial support from high-performing BUs. When overall performance falls below benchmarks, responses diverge based on BU performance. Companies should not only consider overall performance but also the revenue contributions of individual BUs. A deeper understanding of these organizational dynamics helps corporate managers make better strategic decisions about entry into new product markets, especially during performance shortfalls. The research provides insights for practitioners on using capital from successful BUs to address different corporate performance challenges, particularly when entering new markets. By unpacking these dynamics, the current study provides an actionable roadmap to navigate performance pressures effectively and make informed strategic decisions that drive organizational success.