The Impact of Expectations Manipulation on the Usefulness of Analyst Forecasts in Firm Valuation*

Abstract

This paper examines the impact of expectations manipulation on the usefulness of analyst forecasts in the residual income valuation model. Recognizing that firms may guide down analyst forecast to either truthfully communicate information (legitimate guidance) or mislead analysts to produce beatable forecasts (expectations manipulation), this study first develops a measure to isolate expectations manipulation from the overall forecast guidance. It then assesses forecast usefulness by the performance of forecast-based intrinsic value metrics (V) to predict firm value. The results show that V estimated using manipulated forecasts have less ability to explain stock price and predict future returns. These results remain after controlling for firm size, earnings performance, forecast accuracy, etc. Based on these findings, I conclude that expectations manipulation reduces the usefulness of analyst forecasts in firm valuation, as it impairs the performance of forecast-based valuation models to predict firm value.

Keywords: Residual income valuation, analyst forecast, expectations manipulation, management forecast guidance

JEL Classification: M41, G14