When do Analysts Adjust for Biases in Management Guidance? Effects of Guidance Track Record and Analysts' Incentives

Abstract:     
Prior research indicates that analysts do not fully adjust for the general downward bias in earnings guidance issued by management. We report the results of three experiments designed to investigate how cognitive factors, incentive effects and their interaction help to explain this phenomenon. Our results suggest that analysts do not adjust for the general tendency of companies to issue downwardly-biased guidance, but they do adjust after they learn about a firm's specific bias pattern over time. The degree of adjustment, however, depends on the interactive effects of analysts' incentives, and the consistency and magnitude of bias revealed by a company's guidance track record. Analysts with accuracy incentives adjust for management's track record of downwardly-biased guidance, but those with relationship incentives do not. Furthermore, the difference in adjustment between analysts with relationship and accuracy incentives is larger when the bias track record is inconsistent than when it is consistent. Also, when guidance bias is larger (two cents) relative to smaller (one cent), analysts with relationship incentives only partially adjust, as they appear to strike a balance between accuracy and their desire to please management. These findings have implications for investors, regulators, and the interpretation of prior research.

Number of Pages in PDF File: 37

Keywords: management earnings guidance, track record, incentives, analyst forecasts

JEL Classification: C91, G29, M41

working papers series