Managerial discretion over initial earnings forecasts

Abstract

We investigate managerial discretion over initial management earnings forecasts issued concurrently with earnings announcements. Japan's unique reporting environment, particularly its systematic bundled management forecasts, produces an earnings benchmark (i.e., forecast innovations) to which most studies have paid little attention. A forecast innovation is the difference between management earnings forecasts for year t + 1 and actual earnings for year t at the earnings announcement date. We investigate whether and why managers manipulate their initial forecasts to avoid negative forecast innovations, and how investors respond to them. First, we find that managers engage in forecast management through discretionary forecasts to avoid negative forecast innovations. Second, we reveal that firms that avoid negative forecast innovations enjoy a higher return, even when managers manipulate their forecasts. Finally, we indicate that firms that avoid negative forecast innovations using discretionary forecasts report lower future performance. Overall, our evidence suggests that managers bias their forecasts opportunistically, which has significant implications for investors and regulators.