Exploring the Accrual-Related Optimism in Management Earnings Forecasts

Abstract

In this study, we examine the effect of accrual-based earnings management on the relation between managers’ earnings forecast optimism and accruals (which we label “managers’ accrual-related forecast optimism”). We build on extensive research which finds that managers inflate accruals to meet or beat earnings benchmarks and suggest that managers’ accrual-related forecast optimism can arise because managers issue optimistic forecasts in an attempt to justify inflated accruals. Consistent with expectations, we find that managers’ earnings forecast optimism is positively associated with discretionary accruals (which proxy for accrual-based earnings management) but not with nondiscretionary accruals. Furthermore, managers’ accrual-related forecast optimism is stronger when earnings management constraints are high. Finally, we find a substantial decline in managers’ accrual-related forecast optimism following the enactment of the Sarbanes-Oxley Act of 2002 which restricted managers’ use of accrual-based earnings management. Overall, our results suggest that managers’ accrual-related forecast optimism is at least in part due to intentional decisions made by managers and is not simply a product of forecasting difficulty related to accruals.