Companies can benefit from giving advance notice about earnings. But they need to be smart about it.

Alot of prominent people don’t like the idea of giving the market an early heads-up.

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Critics, who include Warren Buffett, Al Gore and groups like the Chamber of Commerce, have blasted the practice of issuing guidance—advance notices about earnings and other matters. They argue that it wastes managers’ time and encourages short-term thinking, and may even drive companies to seek capital overseas instead of in the U.S.

But a host of research—mine and others’—shows that those arguments don’t hold up. Guidance benefits investors, companies and managers in a number of ways, such as cutting down shareholder lawsuits and giving the market better data to work with. Indeed, research recently published in the Journal of Accounting and Economics documents a significant stock-price drop for companies that announced they were stopping guidance. Far from a waste of time, guidance is a crucial part of an executive’s job.

That said, companies should do it smartly. For one thing, they should issue guidance only when they can predict performance better than analysts—and they should make it part of a broader practice of disclosure that gives investors insight into the company’s plans and progress.

A Vital Component

Let’s start with the most basic argument against guidance: It takes too much time. Critics say executives must set up elaborate and costly forecasting processes, and then answer endless rounds of questions about the numbers they issue. And that prevents them from undertaking other productive activities.

ENLARGE

Philip Anderson

But guidance requires a negligible investment of time. A CEO who doesn’t readily have short- and medium-term performance forecasts shouldn’t guide, and shouldn’t manage. Guidance also increases the circle of analysts following the firm, since guidance data makes it much easier to do their job. And having lots of analysts on board comes in handy in stock issues and proxy contests.

Critics also say that guidance encourages a futile short-term earnings game. Companies, the argument goes, slash R&D or other long-term initiatives to meet earnings estimates—sacrificing future growth.

ENLARGE

But the argument misses a crucial point: Most guidance isn’t short-term. It forecasts several quarters ahead, giving companies a chance to fill in details that wouldn’t show up in regular financial reports.

For instance, reported earnings don’t reflect the progress of the product-development process of innovative companies, such as in biotech. They also ignore recent business initiatives and new contracts signed or canceled, as well as the impact of economic developments—like the European recession—on future performance.

In fact, I further argue that critics are wrong even when companies are providing short-term guidance. For one thing, the game of trying to beat expectations plays out with or without guidance. Doesn’t Google, the famous nonguider, aim to beat the consensus?

Reducing Uncertainty

More broadly, getting more information out helps everyone involved—shareholders, analysts and companies. By sharing information with the market, companies reduce investor uncertainty and prevent stock prices from swinging wildly upon unexpected bad news. My research shows that managers’ quarterly earnings guidance is more accurate than the current analysts’ consensus forecast in 70% of cases. Analysts know this and are quick to revise their forecasts upon the release of guidance.

But warning investors about potential disappointments doesn’t just help protect them from losses—it helps protects companies, too. Guidance released prior to weak earnings is considered a mitigating factor in shareholder lawsuits, and was shown in a study published in 1997 to reduce settlement figures. (Most shareholder lawsuits are settled.)

There’s one more argument the critics often make against guidance: It puts so much pressure on companies that they abandon the U.S. equities market and seek out private equity or foreign listings. But I haven’t found a single example of a company taken private or listed abroad whose managers claimed that the pressure to guide was a major reason. Besides, isn’t it easier just to abstain from guidance? Two-thirds of public companies do just that.

All that said, there are right and wrong ways to do guidance. Here’s a look at some basic principles companies should follow.

• Guide when you are a better prognosticator than analysts. For the past three to five years, compare your internal quarterly earnings forecasts with analysts’ public forecasts, relative to the subsequently released earnings. If you beat analysts, chalk one up for guidance. If not, how come outsiders know more about your company’s future than you do?

• If most of your industry peers release guidance regularly, you don’t want to stand out as a refusenik. Investors will suspect that you have something to hide or that you aren’t on top of things.

• Guidance is particularly useful when uncertainty about your company’s prospects is high. Look at the range (or dispersion) of analysts’ forecasts around the consensus—an uncertainty measure. If your company’s range is larger than competitors’, by all means guide.

• When forthcoming earnings will disappoint investors, you should issue a warning as soon as possible with a credible explanation of what went wrong and the corrective actions taken. Your stock will be hit, but it will be hit anyway when the bad news comes out.

• Don’t try to game guidance. You’ll lose credibility if you release conservative guidance just so you can beat earnings estimates later on. Also, be consistent: Don’t guide in good times and abstain in bad.

• Finally, remember that guidance, by itself, isn’t enough. It should be part of a wider strategy of regularly disclosing fundamental information about the company and its business model—from the progress of innovative activities to changes in the customer base. Letting analysts in on these details will keep the market informed about—and interested in—the business.

Mr. Lev is the Philip Bardes professor of accounting and finance at New York University’s Stern School of Business and the author of Winning Investors Over (Harvard Business Review Press, 2012). He can be reached at reports@wsj.com .