Soft-Talk Management Cash Flow Forecasts: Verifiability, Credibility and Stock Price Effects
48 Pages Posted: 10 Jan 2006 Last revised: 31 Dec 2007
Date Written: December 30, 2007
We exploit a novel feature of management cash flow forecasts to investigate how managers' discretion over forecast verifiability affects the credibility and stock price effects of such forecasts. Many management cash flow forecasts are issued with an equivocal definition of the cash flow number being forecasted. We refer to such forecasts as "soft-talk" cash flow forecasts, and expect that due to their lower ex-post verifiability, they will have lower credibility and hence a smaller effect on stock prices when compared to unequivocal management cash flow forecasts. Our findings suggest that "soft-talk" is associated with an optimistic bias in management cash flow forecasts. Furthermore, managers' decision to issue "soft-talk" cash flow forecasts is related to economic factors including litigation risk, financial distress, actual cash flow performance, analyst following and the issuance of prior cash flow forecasts. While we find that management cash flow forecasts in general affect stock prices, consistent with the low verifiability of and optimistic bias in "soft-talk" cash flow forecasts, investors do not find good news "soft-talk" management cash flow forecasts credible. Finally, we examine the interaction between management earnings and cash flow forecasts and document that they serve to enhance the credibility in each other by reducing optimistic forecast bias. We also find that the bias in both types of forecasts is related and that the relation is a function of forecast difficulty.
Keywords: Forecast verifiability, forecast bias, management cash flow forecasts
JEL Classification: G12, M41, M45
Suggested Citation: Suggested Citation