The Consistency of Mandatory and Voluntary Management Earnings Forecasts and Implications for Analyst and Investor Information Processing

47 Pages Posted: 14 May 2016

See all articles by Richard A. Cazier

Richard A. Cazier

University of Texas at El Paso - Department of Accounting

Sonja O. Rego

Indiana University - Kelley School of Business - Department of Accounting

Xiaoli (Shaolee) Tian

Georgetown University - Department of Accounting and Business Law

Ryan J. Wilson

University of Oregon

Date Written: April 21, 2016

Abstract

In this study we examine whether managers' voluntary forecasts of future earnings are consistent with the implicit forecasts of future earnings that underlie a specific mandatory accrual, the valuation allowance. This accrual relies heavily on managerial estimation and is also based, in part, on managers’ private, forward-looking information. Thus, it provides an ideal setting to investigate the interplay between voluntary and mandatory financial disclosures. By examining the consistency between the voluntary and mandatory forecasts, we are also able to provide insight into whether the predictable accrual-related bias in voluntary earnings forecasts carries over into the mandatory forecast embedded in the valuation allowance. We then investigate whether the biased voluntary earnings guidance helps analysts and investors more accurately interpret the information in valuation allowance changes about future earnings expectations. To increase the power of our tests we utilize a sample of loss firms, which frequently record valuation allowances to fully or partially offset deferred tax assets.

We first document that more than 62 percent of our sample of loss firms report valuation allowance changes and management earnings guidance that convey the same basic information about future earnings (i.e., either both forecast profit or both forecast loss). Thus, these voluntary and mandatory forecasts are largely consistent with each other. We then provide evidence that managers provide overly pessimistic forecasts for observations whose valuation allowance changes signal bad news about future earnings, but overly optimistic forecasts for observations whose valuation allowance changes signal strong good news about future earnings. Finally, our results suggest that managers' biased earnings forecasts actually help analysts and investors more accurately interpret the information about future earnings in valuation allowance changes. Our findings provide new insights into actions managers can take to improve investor and analyst processing of financial statement-based tax information.

Keywords: Valuation Allowance, Management Forecasts, Voluntary Disclosure, Mandatory Disclosure

JEL Classification: G14, M41, M49,

Suggested Citation

Cazier, Richard A. and Rego, Sonja O. and Tian, Xiaoli (Shaolee) and Wilson, Ryan J., The Consistency of Mandatory and Voluntary Management Earnings Forecasts and Implications for Analyst and Investor Information Processing (April 21, 2016). Kelley School of Business Research Paper No. 16-42. Available at SSRN: https://ssrn.com/abstract=2779712 or http://dx.doi.org/10.2139/ssrn.2779712

Richard A. Cazier

University of Texas at El Paso - Department of Accounting ( email )

500 W University Ave
El Paso, TX 79902
United States
915-747-7755 (Phone)

Sonja O. Rego (Contact Author)

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
812 855-6356 (Phone)

HOME PAGE: http://kelley.iu.edu/Accounting/faculty/page12887.cfm?ID=33017

Xiaoli (Shaolee) Tian

Georgetown University - Department of Accounting and Business Law ( email )

McDonough School of Business
Washington, DC 20057
United States

Ryan J. Wilson

University of Oregon ( email )

1280 University of Oregon
Eugene, OR 97403
United States

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