Do Managers Bias their Forecasts of Future Earnings in Response to their Firm’s Current Earnings Announcement Surprises?

Abstract

The vast majority of managers’ earnings forecasts are issued concurrently (i.e., “bundled”) with their firm’s current earnings announcement. We document a predictable bias in these forecasts – the forecasts fail to fully reflect the persistence of the current earnings surprise. Specifically, we find that managers issue (1) optimistically biased forecasts alongside negative earnings surprises and (2) pessimistically biased forecasts alongside large positive earnings surprises. Bayesian updating implies this bias could be unintentional, but we find that the bias is stronger when managers have greater incentives and fewer constraints to issue biased forecasts, suggesting that, to some extent, the bias might be intentional. Relatedly, although managers typically have better information about their firm’s earnings than analysts, we show that analyst reliance on these biased management forecasts represents a mechanism (and an alternative interpretation) for a similar analyst underreaction to current earnings attributed in prior literature to analysts’ cognitive bias. We also find that, on average, investors do not appear to initially understand the bias in these forecasts but eventually unravel it over longer windows. However, investors more quickly unravel the bias when the manager has a history of issuing these biased forecasts and when the firm has relatively more sophisticated investors. Overall, we document that managers’ forecasts appear to repeatedly underweight the persistence of current earnings surprises, are biased in ways that improve investors’ perceptions of managers’ ability, and that this behavior concentrates in subsamples where outsiders have a harder time recognizing any bias.