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
Date Written: December 23, 2013
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
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