Disagreement, Speculation and Management Forecasts

Abstract

We examine the properties of management forecasts in the presence of disagreement-based speculation. We construct a novel measure of speculative trading and confirm it is strongly positively related to equity overvaluation. For identification, we use exogenous variation in speculative trading around the reconstitution of the Russell 1000/2000 indices. Using this approach, we document a strong negative effect of speculative trading on the frequency and likelihood of management forecasts. The effect is stronger when arbitrage is costlier and stronger still when managers have more equity-based incentives. We also find that managers sell their own equity and issue more stock to benefit from speculative trading, suggesting that managers are aware of the link between speculation and mispricing. For firms issuing forecasts, managers issue less precise and more optimistic forecasts when speculative trading is higher. Our results suggest that in the presence of disagreement-based speculative trading, managers choose to “not rock the boat” with any incremental news about fundamentals to prolong the disagreement among investors and the resulting equity overvaluation.

Keywords: Speculation, Disagreement, Management Forecasts, Stock Prices, Short Sale Constraints, Speculative Trading

JEL Classification: C50, G12, G14, M41