Are more able managers good future tellers? Learning from Japan

Baik et al. (2011) find that high-ability managers in the U.S. are more likely to issue accurate management earnings forecasts. Focusing on Japan, where management earnings forecasts are effectively mandated, we extend the literature by exploring (1) whether the relationship between managerial ability and forecast accuracy is unique to the U.S. disclosure system, where management forecasts are voluntary, and (2) how high-ability managers increase their forecast accuracy. We find that managerial ability is negatively associated with forecast errors based on initial forecasts, suggesting that high-ability managers are more likely to issue accurate forecasts at the beginning of the fiscal year. We then show that high-ability managers are less likely to revise their initial earnings forecasts and less likely to use earnings management to improve the accuracy of their earnings forecasts. Our findings show that, while high-ability managers are more likely to issue accurate initial management forecasts, low-ability managers are more likely to revise their forecasts and conduct earnings management to reduce their forecast errors.     

The accuracy of earnings forecasts in IPO prospectuses on the Kuala Lumpur Stock Exchange

This paper examines the accuracy of earnings forecasts made by managers of Malaysian initial public offerings (IPOs) during the period 1984–1995. It is a mandatory requirement for Malaysian IPOs to furnish earnings forecasts together with the opinions thereon of the auditors and the lead underwriter in their prospectuses. Their accuracy is measured by forecast errors, absolute forecast errors, squared forecast errors and standardised forecast errors. The results suggest that, on average, managers under-forecast earnings by 33.37%. A comparison with the naive no change model in earnings suggests that 96 out of 122 companies outperform this model. A number of company specific characteristics (size, age, forecast interval, gearing, proportion of shares retained by owners, auditor reputation and industry) are tested. The results reveal that both the age and industry classification of the company are statistically significant, and that management earnings forecasts are particularly inaccurate where firms experience a decline in earnings. Key words: accuracy of prospectus earnings forecasts, initial public offerings, accounting in Malaysia.     

Determinants of analysts’ revenue forecast accuracy

This study investigates financial analysts’ revenue forecasts and identifies determinants of the forecasts’ accuracy. We find that revenue forecast accuracy is determined by forecast and analyst characteristics similar to those of earnings forecast accuracy—namely, forecast horizon, days elapsed since the last forecast, analysts’ forecasting experience, forecast frequency, forecast portfolio, reputation, earnings forecast issuance, forecast boldness, and analysts’ prior performance in forecasting revenues and earnings. We develop a model that predicts the usefulness of revenue forecasts. Thereby, our study helps to ex ante identify more accurate revenue forecasts. Furthermore, we find that analysts concern themselves with their revenue forecasting performance. Analysts with poor revenue forecasting performance are more likely to stop forecasting revenues than analysts with better performance. Their decision is reasonable because revenue forecast accuracy affects analysts’ career prospects in terms of being promoted or terminated. Our study helps investors and academic researchers to understand determinants of revenue forecasts. This understanding is also beneficial for evaluating earnings forecasts because revenue forecasts reveal whether changes in earnings forecasts are due to anticipated changes in revenues or expenses.     

Analyst revenue forecast reporting and the quality of revenues and expenses

We decompose earnings quality into revenue and expense quality and examine their associations with analyst propensity to supplement their earnings forecasts with revenue forecasts. Analysts report more revenue forecasts to I/B/E/S when expense quality is low to compensate for the low accuracy of their earnings estimates, which has a positive association with expense quality. Expense quality is unassociated with revenue forecast accuracy, thus revenue forecasts become increasingly useful for valuing firms when expense quality is low. Analysts report fewer revenue forecasts when revenue quality is low because both earnings and revenue forecast accuracy decline as revenue quality deteriorates. To control for endogeneity, we use firm‐fixed effects to control for unobserved time‐invariant heterogeneity across firms, instrumental variables regressions and regression in changes.     

On the Use of Intra-Industry Information to Improve Earnings Forecasts

We investigate whether earnings forecasts are improved by earlier earnings disclosures by firms in the same industry. We find improvements for time series forecasts, but not for analysts' forecasts. Considering prior earnings announcements reduces correlations between forecast errors and security price reactions to earnings announcements, even when incorporating these announcements improves forecast accuracy. Our explanation for this anomaly, which is supported by additional analysis, is that intra-industry information facilitates predicting transitory, rather than permanent, earnings components. The question of whether information transfers improve earnings forecasts provides the context for the analysis, but the primary contribution is the documentation of intra-industry information transfers in a setting other than capital markets.     

积极回应内部控制法案与管理层利润预测精度——基于日本数据的实证研究

以日本上市公司为研究对象,在考虑盈余管理行为的基础上分析并检验积极回应内部控制法案的上市公司是否具有较高的管理层利润预测精度。结果表明,那些委托会计师事务所构建和完善其内部控制系统以应对内部控制法案的上市公司具有较高的管理层利润预测精度。因此,有效的内部控制有助于企业实施全面预算管理。     

The association between qualitative management earnings forecasts and discretionary accounting in the Netherlands

This paper examines whether there is an association between discretionary accounting and the accuracy of long-run forecasts of annual earnings disclosed voluntarily by Dutch companies in the directors’ report. In particular, investigations were made of the consistency in the sign and direction of discretionary accounting techniques and qualitative earnings forecasts. Long-run forecasts are defined, for the purposes of this paper, as forecasts made at least seven months before the year-end. Although not mandatory, qualitative forecasts are released by well over 60% of the listed companies in the Netherlands. Empirical results indicate that there is consistency in the sign and direction of qualitative earnings forecasts and discretionary accounting. After adopting discretionary accounting, the forecast errors are reduced if the company can reach the management earnings forecast (target). In the event that reserves are insufficient to accomplish this goal, managers choose their next best option and take an earnings bath in order to maximize reserves available for future use. By partitioning the sample in various sub-sets it is shown that earnings management and forecast errors occur most in the extreme ranges of financial performance. Overall, the study shows that management engages in discretionary accounting to present results in line with the disclosed qualitative earnings forecasts in their directors’ reports. Whilst discretionary accounting may clearly improve the consistency of companies’ earnings forecasts released via the directors’ reports and the actual earnings, managers’ earnings forecasts are sometimes disclosed in anticipation of planned discretionary accounting actions.     

Market implied future earnings and analysts’ forecasts

This study provides evidence on market implied future earnings based on the residual income valuation (RIV) framework and compares these earnings with analyst earnings forecasts for accuracy (absolute forecast error) and bias (signed forecast error). Prior research shows that current stock price reflects future earnings and that analyst forecasts are biased. Thus, how price-based imputed forecasts compare with analyst forecasts is interesting. Using different cost of capital estimates, we use the price-earnings relation and impute firms’ future annual earnings from three residual income (RI) models for up to 5 years. Relative to I/B/E/S analyst forecasts, imputed forecasts from the RI models are less or no more biased when cost of capital is low (equal to a risk-free rate or slightly higher). Analysts slightly outperform these RI models in terms of accuracy for immediate future (1 or 2) years in the forecast horizon but the opposite is true for more distant future years when cost of capital is low. A regression analysis shows that, in explaining future earnings changes, analyst forecasts relative to imputed forecasts do not impound a significant amount of earnings information embedded in current price. In additional tests, we impute future long-term earnings growth rates and find that they are more accurate and less biased than I/B/E/S analyst long-term earnings growth forecasts. Together, the results suggest that the RIV framework can be used to impute a firm’s future earnings that are high in accuracy and low in bias, especially for distant future years.     

CEO stock options and analysts’ forecast accuracy and bias

This paper investigates the relationship between CEO stock options and analysts’ earnings forecast accuracy and bias. A higher level of stock options may induce managers to undertake riskier projects, to change and/or reallocate their effort, and to possibly engage in gaming (such as opportunistic earnings and disclosure management). These managerial behaviors result in an increase in the complexity of forecasting and hence, less accurate analysts’ forecasts. Analysts’ optimistic forecast bias may also increase as the level of stock options pay increases. Because forecast complexity increases with stock options pay, analysts, needing greater access to management’s information to produce accurate forecasts, have incentives to increase the optimistic bias in their forecasts. Alternatively, a higher level of stock options pay may lead to improved disclosure because it better aligns managers’ and shareholders’ interests. The improved disclosure, in turn, may result in more accurate and less biased analysts’ forecasts. Our empirical evidence indicates that analysts’ earnings forecast accuracy decreases and forecast optimism increases as the level of CEO stock options increases. This evidence suggests that the incentive alignment effects of stock options are more than offset by the investment, effort allocation and gaming incentives induced by stock options grants to CEOs.     

The Effect of Issuing Biased Earnings Forecasts on Analysts' Access to Management and Survival

This study offers evidence on the earnings forecast bias analysts use to please firm management and the associated benefits they obtain from issuing such biased forecasts in the years prior to Regulation Fair Disclosure. Analysts who issue initial optimistic earnings forecasts followed by pessimistic earnings forecasts before the earnings announcement produce more accurate earnings forecasts and are less likely to be fired by their employers. The effect of such biased earnings forecasts on forecast accuracy and firing is stronger for analysts who follow firms with heavy insider selling and hard‐to‐predict earnings. The above results hold regardless of whether a brokerage firm has investment banking business or not. These results are consistent with the hypothesis that analysts use biased earnings forecasts to curry favor with firm management in order to obtain better access to management's private information.     

Does revenue-expense matching play a differential role in analysts’ earnings and revenue forecasts?

This paper investigates whether matching has differential implications for the accuracy of analysts' earnings and revenue forecasts. We construct a novel measure of firm-level matching and document that matching improves analysts' earnings forecasts to a greater extent than their revenue forecasts. We also document matching's differential impact on analysts' earnings and sales forecasts by proposing a new count metric capturing a wedge in the accuracy of earnings and revenue forecasts. In additional tests, we report that the differential impact of matching is less (more) pronounced in a situation where the balance sheet (income statement) orientation likely dominates. We also report that matching's differential role is weaker (stronger) when firms have high intangible intensity (analysts have appropriate resources or expertise). In short window tests, matching's role in analysts' forecast revisions is more pronounced for earnings than sales forecasts. Overall, these results show how analysts benefit from better revenue-expense matching.     

Analysts' forecasts of Japanese firms' earnings: additional evidence

This article examines analysts' forecasts of Japanese firms' earnings during Japan's economic burst period in the 1990s. Using the evidence of analyst earnings forecasts in the United States as a benchmark, the article documents the following three findings. First, whereas the forecast accuracy of U.S. analysts following U.S. firms improves over time, the forecast accuracy of U.S. and Japanese analysts following Japanese firms does not. Second, whereas decreases in forecast errors of U.S. analysts following U.S. firms are best explained by decreases in forecast bias of the analysts, increases in forecast errors of U.S. and Japanese analysts following Japanese firms are best explained by increases in the frequency of losses experienced by Japanese firms. Third, Japanese analysts forecast earnings less accurately than do U.S. analysts. These findings reflect the difficulty of producing accurate earnings forecasts during economic downturns. They also suggest that Japanese analysts are more bound than their U.S. counterparts by cultural ties that impede forecast accuracy.     

The effect of consistency in book-tax differences on analysts’ earnings forecasts: Evidence from forecast accuracy and informativeness

This study examines the relationship between the consistency of book-tax differences and the quality of analysts’ earnings forecasts. We find that the consistency of book-tax differences is associated with more accurate and informative forecasts. This suggests that the information embedded in the consistency of book-tax differences plays an important role in elevating the quality of analysts’ forecasts. Furthermore, the effect of consistency in book-tax differences on analyst forecast quality is greater for firms with noisier information environment. Finally, we find that the relation between consistency in book-tax differences and improvements in forecast accuracy and informativeness is stronger after the implementation of Regulation Fair Disclosure, which increased the role of public information in analysts’ forecasts.     

Risk-based forecasting and planning and management earnings forecasts

This study examines the association between a firm’s internal information environment and the accuracy of its externally disclosed management earnings forecasts. Internally, firms use forecasts to plan for uncertain futures. The risk management literature argues that integrating risk-related information into forecasts and plans can improve a firm’s ability to forecast financial outcomes. We investigate whether this internal information manifests itself in the accuracy of external earnings guidance. Using detailed survey data and publicly disclosed management earnings forecasts from a sample of publicly traded U.S. companies, we find that more sophisticated risk-based forecasting and planning processes are associated with smaller earnings forecast errors and narrower forecast widths. These associations hold across a variety of different planning horizons (ranging from annual budgeting to long-term strategic planning), providing empirical support for the theoretical link between internal information quality and the quality of external disclosures.     

证券分析师VS统计模型:证券分析师盈余预测的相对准确性及其决定因素

本文使用2005年35家券商对我国上市公司做出的每股盈余预测数据,考察了证券分析师盈余预测相对于统计模型的相对准确性及其决定因素。我们发现,我国证券分析师做出的盈余预测,同以年度历史数据为基础的统计模型得出的盈余预测相比,预测误差较小,证券分析师盈余预测具有一定的优势;但同某些以季度历史数据为基础的统计模型得出的盈余预测相比,预测误差较大,证券分析师盈余预测不具有优势。我们同时考察了决定证券分析师盈余预测相对准确性的决定因素。我们发现,公司每股盈余的波动性越大,公司上市越晚,跟踪公司的分析师越多,证券分析师的优势就越大。我们的研究对证券分析师以及投资者都有一定的启示作用。     

Evidence That Management Earnings Forecasts Do Not Fully Incorporate Information in Prior Forecast Errors

Abstract:  This paper investigates whether managers fully incorporate the implications of their prior earnings forecast errors into their future earnings forecasts and, if not, whether this behavior is related to the post-earnings announcement drift. I find a positive association in consecutive management forecast errors, suggesting that managers underestimate the future implications of past earnings information when forecasting earnings. I also find that managers underestimate the information in their prior forecast errors to a greater extent when they make earnings forecasts with a longer horizon. Finally, I find that, similar to managers, the market also underreacts to earnings information in management forecast errors, which leads to predictable stock returns following earnings announcements.     

The accuracy of management dividend forecasts in Australia

Dividends have direct cash flow consequences for investors and are important for signalling reasons. Consequently, investors, analysts and managers typically forecast future dividends and report them in various ways. Yet the accuracy of dividend forecasts has been largely neglected in empirical finance. We examine the accuracy of managers' dividend forecasts in Australian IPO prospectuses (a companion paper examines the analysts' dividend forecasts). Managers' dividend forecasts are optimistically biased. Nevertheless, they are substantially more accurate and less biased than their earnings counterparts. Differences in retained ownership and the predictability of earnings help explain why some dividend forecasts are more accurate than others.     

Investor sentiment and management earnings forecast bias

This study investigates whether investor sentiment is associated with behavioral bias in managers’ annual earnings forecasts that are generally issued early in the year when uncertainty is relatively high. I provide evidence that management earnings forecast optimism increases with investor sentiment. Furthermore, I find that managers’ annual earnings forecasts are more pessimistic during low‐sentiment periods than during normal‐sentiment periods. Since managers lack incentives to further deflate stock prices during a low‐sentiment period, this evidence indicates that sentiment‐related management earnings forecast bias is likely to be unintentional. In addition, I find that the relationship between management earnings forecast bias and investor sentiment is stronger for firms with higher uncertainty, consistent with investor sentiment having a greater influence on management earnings forecasts when uncertainty is higher.     

The effect of Regulation FD on the properties of management earnings forecasts

We investigate Regulation FD’s (FD) effect on management earnings forecast properties. We posit FD’s prohibition on private manager-analyst communication reduces (increases) optimism (pessimism) in management earnings forecasts. Prior to FD, managers could avoid publicly retracting prior optimistic forecasts by privately communicating with analysts, who could lower investor expectations with a new analyst forecast. After FD, managers with optimistic forecasts must either publicly admit their optimism by issuing a new management forecast or they must negatively surprise investors at the earnings announcement. Further, FD forces managers to use public forecasts instead of private communications to establish beatable expectations. Our evidence suggests FD reduced optimism in management forecasts. This reduction in optimistic bias is not offset by an increase in pessimistic bias. Consistent with this, we further find post-FD improvements in forecast accuracy and informativeness. We find no such changes around several potentially confounding events or for foreign firms surrounding FD. Overall, our evidence suggests FD improved firms’ forecast properties (less bias, greater accuracy, and greater informativeness).     

Value relevance of analyst earnings forecasts in emerging markets

Even though research in accounting and finance has extensively examined the role of financial analysts in developed economies, this issue has not been thoroughly examined in an emerging market setting. In this paper, I examine whether, following a market opening, analyst forecast accuracy and the market's reliance on analyst forecasts increase with time. Accuracy is expected to increase over time as analysts exert more effort and gain valuable forecasting experience. Results indicate that time is positively related to analyst forecast accuracy after controlling for a number of other firm and country characteristics. Second, I posit that time should also be related to the market's propensity to use analyst forecasts to form earnings expectations. As markets open and investors become more sophisticated, the reliance on analyst forecasts should also increase. Results are consistent with this expectation. In particular, I find that in the first sub-period earnings expectations based on random walk exhibit greater relative information content than earnings expectations based on analyst forecasts. This pattern is reversed in the third sub-period where analyst forecast errors better explain returns. Incremental information content tests produce similar results. Future research should further investigate the relation between financial analysts and other important market characteristics in emerging economies.