Does Expectations Management Impair the Usefulness of Analyst Forecasts in Firm Valuation?

Abstract

In this paper, I examine how expectations management for the purpose of meeting or beating analyst expectations (MBE) impairs the ability of analyst forecast-based valuation models to predict firms' intrinsic values. I predict that management's manipulation of analyst expectations introduces error in analyst forecasts and reduces their ability to proxy future expected earnings; consequently, valuation models estimated using these manipulated forecasts have less ability than those estimated using non-manipulated forecasts to predict firms' true intrinsic values. The results show that, consistent with my prediction, intrinsic value metrics estimated using manipulated forecasts have less ability to track stock price (as evidenced by their lower correlation with stock prices and less stationary V/P time-series) and to predict future returns. These results provide consistent evidence for the negative impact of expectations management on the ability of accounting valuation models to predict firm value. This study contributes to the literature in two major respects: (i) it introduces an improved measure of expectations management to MBE; and (ii) it proposes expectations management (forecast manipulation) as a new determinant of the ability of accounting valuation models to predict firm value.

Keywords: Expectations management, analyst forecast, firm valuation

JEL Classification: A00