The Effects of Forecast Type and Performance-Based Incentives on the Quality of Management Forecasts

33 Pages Posted: 16 Aug 2013 Last revised: 24 Dec 2013

See all articles by Clara Xiaoling Chen

Clara Xiaoling Chen

University of Illinois at Urbana-Champaign; University of Illinois at Urbana-Champaign - Department of Accountancy

Kristina M. Rennekamp

SC Johnson Graduate School of Management; Cornell SC Johnson College of Business

Flora H. Zhou

Bentley University

Date Written: December 23, 2013

Abstract

Forecasts are vital to every business organization and are key inputs to business decisions such as budgeting, compensation and financial reporting. In this study, we use an abstract experiment to examine how the extent of disaggregation in a management forecast interacts with performance-based incentives to influence the accuracy and bias of management forecasts. We manipulate two factors between subjects at two levels each: forecast type (Disaggregated or Aggregated Forecasts) and performance-based incentives (Presence or Absence of performance-based incentives). Consistent with our predictions, we find that (1) in the absence of performance-based incentives, providing disaggregated forecasts leads to more accurate forecasts than providing aggregated forecasts; while (2) an ordinal interaction between forecast type and performance-based incentives such that providing disaggregated forecasts leads to greater forecast optimism than providing aggregated forecasts in the presence of performance-based incentives, but not in the absence of performance-based incentives. Our study bridges the gap between management accounting and financial accounting research by opening the “black box” of management forecasts and highlighting how internal budgeting and forecasting approaches affect the quality of externally reported forecasts. Our results have important practical implications for managers and investors.

Keywords: forecast type, budgeting, disaggregated forecasts, motivated reasoning, performance-based incentives, forecast quality

Suggested Citation

Chen, Clara Xiaoling and Chen, Clara Xiaoling and Rennekamp, Kristina M. and Zhou, Flora H., The Effects of Forecast Type and Performance-Based Incentives on the Quality of Management Forecasts (December 23, 2013). AAA 2014 Management Accounting Section (MAS) Meeting Paper, Available at SSRN: https://ssrn.com/abstract=2310870 or http://dx.doi.org/10.2139/ssrn.2310870

Clara Xiaoling Chen

University of Illinois at Urbana-Champaign - Department of Accountancy ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

University of Illinois at Urbana-Champaign ( email )

389 Wohlers Hall
1206 S. Sixth Street
Champaign, IL 61820
United States
217-244-3953 (Phone)

Kristina M. Rennekamp

SC Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-255-0500 (Phone)

Cornell SC Johnson College of Business ( email )

Ithaca, NY 14850
United States

Flora H. Zhou (Contact Author)

Bentley University ( email )

175 Forest Street
Waltham, MA 02145
United States

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