The Joint Effect of Management's Prior Forecast Accuracy and the Form of its Financial Forecasts on Investor Judgment

30 Pages Posted: 19 Jan 1999

See all articles by D. Eric Hirst

D. Eric Hirst

University of Texas at Austin

Lisa Koonce

University of Texas

Jeffrey S. Miller

University of Notre Dame - Department of Accountancy

Date Written: December 1998

Abstract

We examine how investor reaction to management earnings forecasts is a joint function of the form of the forecast and management's perceived credibility. In a laboratory experiment involving 126 individual investors, we compare investors' earnings predictions and their confidence therein after receiving point and closed range forecasts issued by managements whose previous forecasting accuracy is known to be either high or low. We used point and range forecasts, because they differ in the degree to which they communicate management's uncertainty about the future. We use management's prior forecasting accuracy as a measure of management's credibility, because prior research has documented the importance of this factor when considering the usefulness of management's voluntary forecasts.

Our results show that, as expected, investors' earnings predictions are responsive to management's forecasts. However, as we hypothesized, forecast form did not influence investors' earnings estimates. In contrast, investors' confidence in their earnings predictions was influenced by the form of management's forecasts, but this effect emerged only when management was previously accurate in their forecasting. A similar interactive pattern was found in the dispersion of investors' predictions about the company's future earnings. Finally, consistent with the hypothesis that confidence is an important determinant of investor behavior, we find that investors' judgments of future stock price appreciation are a positive function of both unexpected earnings and the change in their confidence.

Our study extends the literature on management forecasts by empirically testing the joint influence of management's credibility (i.e., forecasting accuracy) and forecast form. The prior literature has argued that both factors should be important, but has not delineated whether or how these two factors might interact. We present a theoretical framework that indicates when both factors should influence investor judgment.

JEL Classification: M41, G12, C91, D82

Suggested Citation

Hirst, D. Eric and Koonce, Lisa L. and Miller, Jeffrey S., The Joint Effect of Management's Prior Forecast Accuracy and the Form of its Financial Forecasts on Investor Judgment (December 1998). Available at SSRN: https://ssrn.com/abstract=145610 or http://dx.doi.org/10.2139/ssrn.145610

D. Eric Hirst (Contact Author)

University of Texas at Austin ( email )

CBA 4M.202 McCombs School of Business
Austin, TX 78712
United States
512-471-5565 (Phone)
512-471-3904 (Fax)

HOME PAGE: http://www.mccombs.utexas.edu/faculty/Eric.hirst/

Lisa L. Koonce

University of Texas ( email )

Dept. of Accounting
McCombs School of Business
Austin, TX 78712
United States
512-471-5576 (Phone)
512-471-3904 (Fax)

Jeffrey S. Miller

University of Notre Dame - Department of Accountancy ( email )

Mendoza College of Business
Notre Dame, IN 46556-5646
United States

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