Is the Strength of the Management Forecast Argument Associated with Forecast Accuracy? Evidence from European Financial Reports

Abstract

Building on the Claim-Data-Warrant model of argumentation by Stephen E. Toulmin (1958/2003), this paper investigates whether the argumentative strength (Warrant) of management forecasts is related to forecast accuracy, and more specifically, whether it is the most important determinant among the three elements. It adds to Trueman’s (1986) signaling theory by arguing that managers do not signal their ability to predict changes in the outlook only by deciding to release a forecast and its type (C) but also by deciding to reference specific type of information (D) to provide a solid forecast argument (W). Using a sample of 517 Revenue, Earnings and Profit margin forecasts by European listed companies this paper documents a positive relationship between the strength of the forecast argument and accuracy (Hypothesis 1). While references to internal information are not related to accuracy (Hypothesis 2), interaction tests indicate that supporting Revenue forecasts with internal actions increases accuracy expectancy by 7.7 times when the argument is strong. Forecast type is related to accuracy, with negative forecasts 1.8 times likelier to hit their target than other forecasts (Hypothesis 3). Tests combining the Toulmin components (Hypothesis 4a) indicate that when management explains negative changes (C) with external factors (D), accuracy likelihood increases 21-fold with strong arguments (W). Evidence for strong, positive arguments referencing internal actions is nearly significant (Hypothesis 4b). Overall, the findings suggest that as the locus of the forecast argument the Warrant is the most important signal of managerial ability among these three elements making up the textual forecast.