CEO Optimism, Analyst Rationality, and Earnings Forecast Bias

Abstract

This paper examines analysts’ forecast behavior in a setting in which CEOs are optimistic and analysts react rationally to CEO optimism. Using insider-trading behavior to capture CEO optimism, we document that the bias in eight-month-ahead analysts’ consensus forecasts is negatively related to the level of CEO optimism. The negative relation is stronger for small firms and for firms with low analyst followings, consistent with the notion that CEOs of firms operating in a poor information environment exert more influence on analysts. Further, analysts revise their forecasts for next year’s earnings less downward relative to their revision for current year’s earnings for firms with more optimistic CEOs, a result consistent with the idea that analyst forecast bias is an equilibrium outcome in response to CEO optimism. Finally, the stock price reaction to downward forecast revisions is less negative for firms with optimistic CEOs, indicating that investors, at least partially, understand the implications of CEO optimism for analysts’ forecast bias and subsequent revisions.

Keywords: Managerial optimism, analyst forecast, rationality