Soft-Talk Management Cash Flow Forecasts: Verifiability, Credibility and Stock Price Effects

48 Pages Posted: 10 Jan 2006 Last revised: 31 Dec 2007

See all articles by Yan Cao

Yan Cao

Simon School, University of Rochester

Charles E. Wasley

Simon School, University of Rochester

Joanna S. Wu

University of Rochester - Simon Business School

Date Written: December 30, 2007

Abstract

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

Cao, Yan and Wasley, Charles E. and Wu, Joanna, Soft-Talk Management Cash Flow Forecasts: Verifiability, Credibility and Stock Price Effects (December 30, 2007). Simon School Working Paper No. FR 06-01. Available at SSRN: https://ssrn.com/abstract=874106 or http://dx.doi.org/10.2139/ssrn.874106

Yan Cao

Simon School, University of Rochester ( email )

Rochester, NY 14627
United States

Charles E. Wasley

Simon School, University of Rochester ( email )

Rochester, NY 14627
United States
585-275-3362 (Phone)
585-442-6323 (Fax)

Joanna Wu (Contact Author)

University of Rochester - Simon Business School ( email )

Carol Simon Hall 3-160D
Rochester, NY 14627
United States
585-275-5468 (Phone)
585-442-6323 (Fax)

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