Does the Stock Market Know the Systematic Bias in Management Earnings Forecasts?: Empirical Evidence from Japan

Abstract

This paper investigates the effect of ten factors on bias in management earnings forecasts (MEF) using a sample of 28,000 forecasts announced by Japanese firms over the period 1979-1999. The ten factors are macroeconomic influence, industry, firm size, Exchange/OTC, external financing, financial distress, prior management forecast errors, growth, losses and management forecasts of dividends. Both univariate and multivariate analyses show that these factors are all associated with bias in MEF. Moreover, analysts appear to be aware of these factors that influence management forecast errors although they do not fully incorporate them into their earnings forecasts. Consequently, abnormal returns can be obtained by predicting errors in MEF. The findings in this paper may suggest that market participants have a “credibility threshold” for management forecasts.