Consistent Earnings Growth and the Credibility of Management Forecasts

Abstract

This paper examines the relation between a series of past earnings increases and the credibility of voluntary management earnings forecasts. We demonstrate that both analyst forecast revisions and stock price reactions around management earnings forecasts that contain good news are more pronounced when the firm has posted a string of recent earnings increases. These results are consistent with our primary hypothesis that voluntary management earnings forecasts are more believable when they are made by firms with a history of consistent growth in earnings. This effect is more pronounced when firms are not widely followed by analysts. Additional analysis suggests that management forecasts are more accurate relative to ex post realized earnings when made by a firm with consistent growth in prior earnings. The effect of prior earnings growth on the credibility of management earnings forecasts is reduced when the level of net assets suggests a history of prior earnings management.

Keywords: Credibility of management forecasts, Voluntary disclosure

JEL Classification: M41