The Strength of Argumentation in European Management Revenue Forecasts During Times of Heightened Economic Uncertainty – Do Financial Analysts Care?

Abstract

After the financial crisis of 2008–2009, accounting research has placed considerable focus on developing new methods for analyzing forward-looking narrative statements in corporate disclosures. This paper uses Toulmin’s (1958/2003) Claim-Data-Warrant argumentation scheme to develop a unique and practical manual measure to overcome some of the challenges existing methods are yet to meet. It examines the relation between the strength of the management revenue forecast argument and three outcomes, 1) ex post forecast accuracy, 2) the incidence of analyst revisions, and 3) the rate of convergence in analyst estimates. Forecast arguments are deemed strong if the forecast claim and the supporting data are comparatively precise. Using a sample of full-year revenue forecasts by European companies during crisis years 2008 and 2009, it shows that the odds that management revenue forecasts meet their target increase as the strength of the forecast argument (i.e. warrant) increases. These findings indicate that the contemporaneous warrant can be used as an alternative to ex post verification of realized revenues when economic visibility is poor. Despite the connection, tests on analyst reactions provide mixed results. While the evidence indicates that analyst revision activity is unaffected by the warrant, it also reveals that the activity increases with forecast news, even if news is negatively correlated with argumentative strength. However, further tests show that updated analyst estimates converge at a significantly greater rate when the management forecast argument is strong, indicating that the warrant carries value relevant information. These findings take Trueman's (1986) signaling theory a step forward by demonstrating that management do not signal their ability to predict their firm's future performance only by releasing guidance but also by releasing guidance that is argumentatively solid. They also imply that managers can reduce their firm’s cost of capital by providing convincing reasoning.

Keywords: revenue forecasts; forecast accuracy; analysts’ revisions; argumentation; Stephen E. Toulmin

JEL Classification: M4, G1, C5