The Dynamics of Earnings Forecast Management

University of Illinois Working Paper

32 Pages Posted: 26 Mar 2003

See all articles by Dan Bernhardt

Dan Bernhardt

University of Illinois at Urbana-Champaign - Department of Economics

Murillo Campello

Cornell University - Samuel Curtis Johnson Graduate School of Management; National Bureau of Economic Research (NBER)

Date Written: December 29, 2002

Abstract

This paper investigates whether firms manage analyst forecasts to generate positive earnings surprises and the consequences of such forecast management. We first document that firms "talk down" forecasts. Forecasts of quarterly earnings issued later in the forecasting horizon grow increasingly pessimistic on average. More importantly, the exact timing of changes in earnings forecasts turn out to be a key determinant of whether a firm indeed succeeds at generating positive earnings surprises. In particular, (i) changes in consensus early in the forecast horizon have no effect on the probability that earnings will exceed the consensus, (ii) late forecasts that raise the consensus sharply reduce the probability of a positive earnings surprise, and (iii) late forecasts that lower the consensus sharply raise the probability of a positive earnings surprise. These last two findings are the opposite of what would be predicted if deviations of late forecasts from the consensus were due to new information arrival. We then find evidence that investors are systematically "misled" by late arriving forecasts. In particular, downward revisions in the consensus lead to large positive cumulative abnormal returns following the earnings announcement. Finally, while the finding that investors reward firms that successfully manage forecasts down might seem to provide a rationale for downward forecast management, this is not so. Specifically, controlling for the extant earnings-consensus forecast differential, the negative impact of downward forecast revisions on stock price dominates the stock price appreciation following the earnings announcement. This begs the question: Firms manage analyst forecasts (down), but why?

Keywords: Analysts consensus, forecast errors, earnings management

JEL Classification: D82, D84, C25, G29, M41, M43

Suggested Citation

Bernhardt, Dan and Campello, Murillo, The Dynamics of Earnings Forecast Management (December 29, 2002). University of Illinois Working Paper. Available at SSRN: https://ssrn.com/abstract=379263 or http://dx.doi.org/10.2139/ssrn.379263

Dan Bernhardt

University of Illinois at Urbana-Champaign - Department of Economics ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
217-244-5708 (Phone)

Murillo Campello (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

114 East Avenue
369 Sage Hall
Ithaca, NY 14853
United States

HOME PAGE: http://www.johnson.cornell.edu/Faculty-And-Research/Profile.aspx?id=mnc35

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138

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