The Association between the Accuracy of Management Earnings Forecasts and Discretionary Accounting Changes

Abstract

This study examines whether there is an association between discretionary accounting changes and the accuracy of management earnings forecasts. First, we discuss the rationale for management's incentive to improve the accuracy of publicly disclosed earnings forecasts. We then conduct empirical tests to determine whether there is support for the hypothesized relationship between discretionary accounting changes and management forecast accuracy. The empirical results indicate that there is a strong association between high prechange forecast errors and the adoption of discretionary accounting changes. Most accounting changes are associated with significant forecast errors (i.e., deviations between the prechange earnings and predicted earnings are high); after adopting discretionary changes, the deviations are reduced. The results of a comparative analysis using analyst forecasts as a benchmark indicate that accounting changes are adopted when management forecast errors are higher than analyst forecast errors. Accounting changes are not used if management forecast errors are less than or equal to analyst forecast errors. The OLS regression results demonstrate that there is a significant association between the size of management forecast errors and the magnitude of the change in EPS. Overall, the study shows that management has an incentive to engage in discretionary accounting changes to improve the accuracy of their publicly disclosed earnings forecasts. The empirical results are, however, subject to two interpretations. Either discretionary accounting changes are used to improve the accuracy of publicly disclosed management earnings forecasts, or managers' earnings forecasts are sometimes disclosed in anticipation of planned accounting changes.