“A Smooth Market Never Made a Skilled Manager”: How High Ability Management Use Contemporaneous Verification of Precision to Enhance the Credibility of Revenue Forecasts During Times of Heightened Uncertainty

Abstract

This paper uses Toulmin’s (2003) Claim-Data-Warrant argumentation scheme to develop a unique measure to examine the relation between the strength of the management revenue forecast argument and two outcomes, 1) ex post forecast accuracy, and 2) the incidence of analyst revisions, during times of heightened uncertainty. Argumentative strength is gauged through two distinct warrants of the textual forecast, i.e. the sign and the precision agreement between the supporting Data and the forecast Claim. Using a sample of full-year revenue forecasts by European firms during crisis years 2008 and 2009, this study shows that management use the precision agreement warrant effectively to alleviate the heightened information asymmetry problem, as the odds that the forecasts which share this characteristic meet their target multiply. In contrast, positive sign agreement is found to depress ex post revenue accuracy under these conditions. Further evidence suggests that analysts respond when revenue forecasts are imprecise and contain news, but refrain from competing with forecast arguments with strong precision agreement warrants. Analyst revisions are also found to be depressed by positive sign agreement in a crisis setting, echoing the results on ex post accuracy, and challenging prior studies which argue for the predictive ability of positive tone. Overall, these findings expand Trueman’s (1986) signaling theory by suggesting that management do not signal their ability to predict performance only by releasing a forecast but also by releasing a forecast argument made up of comparatively precise Data and Claim elements.

Keywords: forecast accuracy, analyst revision, linguistic tone, precision, argumentation

JEL Classification: G14, D82, M41