Management Earnings Guidance as a Commitment Device
63 Pages Posted: 5 May 2021 Last revised: 11 May 2022
Date Written: May 10, 2022
This paper examines whether issuing management earnings guidance motivates a firm to raise its performance. We hypothesize that managers anticipate failing to attain a forecast reflects poorly on them and would ex post motivate management and employee effort. Thus, managers choose to issue guidance ex ante to commit themselves to exert this heightened effort. Consistent with this commitment, management hone their firm’s production function to raise firm performance. We find evidence supporting this hypothesis: management issue guidance and raise performance at firms where commitment should be most beneficial for the firm, such as when (i) employee productivity is malleable, (i) employee effort is impactful, (iii) performance is credibly measured, and (iv) capital markets strongly reward increased performance. Further, we find that firms alter their operating activities, rather than manage their accruals, to increase performance. The enhancement in firm performance from using managerial earnings guidance as a commitment device is greatest for firms issuing moderately aggressive forecasts and is accomplished by reductions in operating leverage. Inconsistent with concerns that forecasting causes myopia and incentivizes short-term real earnings management, performance increases persist for several years.
Keywords: management earnings forecast, guidance, commitment, performance
JEL Classification: L25, M41
Suggested Citation: Suggested Citation