Do Analysts' Forecasts Fully Reflect the Information in Accruals?

38 Pages Posted: 25 May 2001

See all articles by Anwer S. Ahmed

Anwer S. Ahmed

Texas A&M University - Mays Business School

Jian Zhou

University of Hawaii at Manoa

Khalid Nainar

McMaster University - Michael G. DeGroote School of Business

Date Written: May 2001

Abstract

This study investigates whether financial analysts correctly weight cash flows, accruals and components of accruals in forecasting future earnings. This examination is in the spirit of Sloan (1996) who documents evidence that investors do not correctly distinguish between the cash flow and accrual components of earnings. We find that analysts do distinguish between accruals and cash flows although they generally underweight the information in both accruals and cash flows. More importantly, we find that analysts do not distinguish between discretionary and non-discretionary accruals even though discretionary accruals are less persistent than non-discretionary accruals. Our findings complement and extend the findings in recent studies on analyst forecast inefficiency with respect to the information in accrual and cash flow components of earnings using alternative research designs [Teoh and Wong (1998), Bradshaw, Richardson and Sloan (2000), Barth and Hutton (2000)]. Analysts are considered to play an important role as information intermediaries in educating investors about the future prospects of firms. They are trained in analyzing financial data and have industry expertise as well as detailed firm-specific knowledge through contacts with managers. Thus, one would expect analysts to correctly incorporate the information in earnings components specifically discretionary versus non-discretionary accruals. Our evidence complements evidence in recent studies that raises questions about the ability of analysts, on-average, to correctly incorporate the information in accruals and cash flows in forecasting future earnings. This in turn implies that other outsiders are also likely to find it difficult to undo earnings management via discretionary accruals and therefore provides a rationale for the existence of earnings management.

Keywords: Analysts' forecasts; Discretionary accruals; Forecast efficiency

JEL Classification: G14, M41, M43

Suggested Citation

Ahmed, Anwer S. and Zhou, Jian and Nainar, S. M. Khalid, Do Analysts' Forecasts Fully Reflect the Information in Accruals? (May 2001). Available at SSRN: https://ssrn.com/abstract=269213 or http://dx.doi.org/10.2139/ssrn.269213

Anwer S. Ahmed (Contact Author)

Texas A&M University - Mays Business School ( email )

430 Wehner
College Station, TX 77843-4353
United States

Jian Zhou

University of Hawaii at Manoa ( email )

Honolulu, HI 96822
United States

S. M. Khalid Nainar

McMaster University - Michael G. DeGroote School of Business ( email )

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada

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