Managerial Earnings Forecast Disclosures and the Trading Profits of Privately Informed Investors

Abstract

We examine the effect of a managerial earnings forecast disclosure on the expected profits of a privately informed analyst. We also analyze its effect on the degree of information asymmetry in the marketplace, the level of price informativeness, and analyst forecast accuracy. When the errors in the public and private signals are independent, it is straightforward to show that the analyst's expected trading profits and the level of information asymmetry will decrease, while price informativeness will increase. When a common error component is introduced, though, the impact of the managerial disclosure becomes more nuanced. While some of the analyst's private information is pre-empted by the managerial forecast, the disclosure provides him with information about the common error in his signal. Depending on the precision of the analyst's private information, this positive effect can lead to an increase in expected trading profits. If it does, then the levels of information asymmetry and price informativeness will increase as well. Increasing the precision of the managerial forecast strengthens these effects. When the analysis is extended to allow the analyst to choose the precision of his private information, we find that if he does benefit from a managerial forecast release, then its disclosure will result in his choosing a higher level of precision. Empirically, this will be manifested in an increase in analyst forecast accuracy.