Management Earnings Forecasts: Their Usefulness as a Source of Firm‐specific Information to Security Analysts

Abstract

Although managers frequently release earnings forecasts, little is known about how this information affects investor beliefs. This study compares changes in analyst earnings forecasts following the release of management forecasts: (1) to changes in analyst forecasts of a control sample of nonforecasting firms; and (2) between management forecasts with differing degrees of accuracy. The forecasting error of analyst estimates for firms releasing management forecasts decreases more rapidly than the errors associated with the control firms, which implies that management forecasts are useful. Analysts apparently are capable of determining which management forecasts are most accurate and responding appropriately.

Impression Management Motivations, Strategies and Disclosure Credibility of Corporate Narratives

“…Hence bad news are expected to be, and are often viewed, to be more credible than good news, ceteris paribus (McNichols, 1989;Williams, 1996;Hutton et al, 2003). In addition, management disclosures that contain bad news result in greater stock price reactions and more analyst forecast revisions than those containing good news (Hassell et al, 1988;Williams, 1996;Cairney & Richardson, 1999;Hutton et al, 2003). Comparing the disclosure credibility of financially distressed and non-financially distressed firms, Koch (1999) stated that firms in the verge of financial disclosures or bankruptcy have greater motivations to provide misleading statements as they have greater benefits and fewer costs of providing inaccurate narratives.…”

“…Not all management forecasts are similarly precise (Mercer, 2004). Imprecise disclosure suggests uncertainty of the management and is deemed to be less credible than precise ones (Hassell et al, 1988;King et al, 1990). Investors are more confident depending on one point of forecast than a range of forecasts (Hirst et al, 1999) and more precise results have stronger relationships between unexpected earnings and unexpected returns (Baginski et al, 1993).…”

The use of management forecasts to dampen analysts’ expectations

“…Analysts may put forth effort to undo pessimism in management forecasts since analyst compensation and job tenure are related to forecast accuracy (Stickel, 1992;Mikhail et al, 1999;Hong et al, 2000). Hassell et al (1988), Baginski and Hassell (1990) and Williams (1996) also suggest that analysts are more skeptical of managers' earnings guidance when it is less likely to be reliable. On the other hand, analysts have incentives to repeat management guidance to get future investment banking business (Dugar and Nathan, 1995;Lin and McNichols, 1998;Bryan-Low, 2002).…”

Disclosure and Monitoring: The Effects of Management Earnings Forecasts on the Pay-Performance Relation

“…Consistent with the view that MEFs provide credible new information, tests of the accuracy of these forecasts indicate that they are more accurate than contemporaneous analysts' forecasts (Houston et al, 2007;Hassell and Jennings, 1986;Waymire, 1986). Hassel, Jennings, and Lasser (1988) further find that MEFs have a positive effect on financial analysts' forecast accuracy. Finally, Li and McConomy (2004) find that the provisions of MEFs are credible (i.e., value relevant) signals for their sample of IPO firms.…”