Biased Earnings Forecasts Research Articles

Do analysts who understand accounting conservatism exhibit better forecasting performance?

This study investigates the performance of analysts when they match the asymmetric timeliness of their earnings forecast revisions (i.e., asymmetric forecast timeliness) with the asymmetric timeliness of firms’ reported earnings (i.e., asymmetric earnings timeliness). We find that better timeliness-matching analysts produce more accurate earnings forecasts and elicit stronger market reactions to their forecast revisions. Further, better timeliness-matching analysts issue less biased earnings forecasts, more profitable stock recommendations and have more favorable career outcomes. Overall, our results indicate that analysts’ ability to incorporate conditional conservatism into their earnings forecasts is an important reflection of analyst expertise and professional success.

Effects Of Voluntary Disclosure Of The Schedule Of Manufacturing Cost On Analysts’ Earnings Forecasts: Evidence From Korea

We provide the effects of voluntary disclosure of the schedule of manufacturing cost on analysts’ earnings forecasts. We set up and analyze the disclosure of the schedule of manufacturing cost as a proxy for voluntary disclosure. Specifically, we examine the associations between voluntary disclosure of it and the accuracy of analysts’ earnings forecasts and bias in earnings forecasts. The results of our study are as follows. First, the relationship between voluntary disclosure of the schedule of manufacturing cost and the accuracy of analysts’ earnings forecasts is significant in the positive (+) direction. This means that the accuracy of analysts’ earnings forecasts is higher in the case of the firms that voluntarily disclosed the schedule of manufacturing cost, as compared to other firms. Second, the relationship between voluntary disclosure of the schedule of manufacturing cost and analysts’ bias in earnings forecasts is significant in the negative (-) direction. This means that analysts underestimate earnings in the case of the firms that voluntarily disclose the schedule of manufacturing cost, as compared to other firms. Since the schedule of manufacturing cost is still an interesting item and useful information in the capital market, the results of our study provide important implications not only to managers, but also to investors and supervisory authority. Limitations of our study include the fact that not all diverse variables that affect voluntary disclosure and analysts’ forecasts are considered.

The effect of disclosure regulation on the bias and accuracy of management earnings forecasts in Malaysian IPO prospectuses

PurposeThis paper aims to examine the impact of disclosure regulation on the levels of bias and accuracy in management earnings forecasts disclosed in the prospectuses of Malaysian initial public offering (IPO). Specifically, the authors investigated the two environments of regulation (mandatory versus voluntary) to draw some conclusions regarding the benefits of regulating disclosure of management earnings forecasts.Design/methodology/approachA sample of 111 Malaysian IPOs listing on the Main Market of Bursa Malaysia from January 1, 2004 to February 29, 2012 was used. The paper uses both univariate and multivariate statistical analyses on this sample of IPOs.FindingsThe empirical results of these multivariate regressions indicated that disclosure regulation has positive and significant impact on the bias and accuracy of management earnings forecasts disclosed in IPO prospectus. In general, the study results suggest that using disclosure regulation to improve the quality of IPO earnings forecasts can be, to some extent, an effective strategy.Practical implicationsThe findings of this study have important implications for regulators and investors. The findings can provide them some relevant insights on the improvements to the earnings forecasts accuracy and trends of the forecast (optimistic or pessimistic) after the change from mandatory to voluntary disclosure. Thus, the authorities may learn whether this change is an effective policy or whether the regime of mandatory disclosure was better for IPO companies and should be reversed.Originality/valueThis study is regarded as the first attempt to investigate the impact of reforms in disclosure regulation on the quality of management earnings forecasts of IPO prospectuses in a developing nation such as Malaysia. In spite of this, the paper focuses on a single country, and it contributes significant insights to the debate about the credibility of IPO management earnings forecasts.

Optimism bias in financial analysts' earnings forecasts: Do commissions sharing agreements reduce conflicts of interest?

Implemented in May 2007, the French rules governing commission-sharing agreements (CSAs) consist of unbundling brokerage and investment research fees. The goal of this paper is to analyze the effect of these rules on analysts' forecasts. Based on a sample of one-year-ahead earnings per share forecasts for 58 French firms during the period from 1999 to 2011, we conduct panel data regressions. We show that the analysts' optimistic bias declined significantly after CSA rules, which suggests that these rules are effective at curbing the conflicts of interest between brokerage activities and financial research. Our results are robust to the impact of the Global Settlement and the Market Abuse Directive.

Analyst Forecast Momentum

A great number of academic papers evaluate the potential for incentive-driven bias in sell-side analysts' earnings forecasts. Yet bias does not necessarily invalidate a forecast, nor does it impinge on its relative quality. We find that analysts' forecasts are optimistic relative to recently introduced fundamental alternatives. However, analysts' forecasts have lower absolute deviation and the information in their earnings forecasts has predictive value for near-term stock returns. We propose the latter result as a previously unidentified form of earnings momentum. We find that this form of earnings momentum is even stronger for quarterly forecasts than annual forecasts, suggesting that analysts' have particularly strong incentives directed to forecasting quarterly earnings. Investing with optimistic analysts is a rational investment strategy, rather than a misguided one, when the investment horizon is less than one year.

How do financial analysts interpret industrial firms' corporate refocusing announcements?

This study investigates how analysts perceive the effect of corporate refocusing announcements on UK industrial firms' future earnings by examining current-year and one-year-ahead earnings forecast revisions, current-year target price revisions and earnings forecast errors in the five years surrounding a refocusing announcement year. The results reveal that analysts adjust their earnings forecasts downward in a refocusing announcement year and the following two years, predicting that operating performance in the post-refocusing period is likely to decline relative to their former earnings forecasts. Secondly, there is no evidence that analysts issue biased earnings forecasts after refocusing announcements or that their forecasts appear less accurate. Thirdly, they adjust their earnings forecasts downward in a refocusing announcement year with downward market movement. However, they do not similarly adjust their earnings forecast upward with upward market movement. The magnitude of downward adjustments exceeds that of upward adjustments. They also adjust current-year target price forecasts downward with downward market movement in the year prior to a refocusing announcement.

The effect of underwriter’s market share, spread and management earnings forecasts bias and accuracy on underpricing of Malaysian IPOs

Purpose – Underpricing is one of the most important anomalies associated with initial public offerings (IPOs). The purpose of this paper is twofold; first, it examines the impact of underwriter’s market share and spread on the underpricing of IPOs; and second, it investigates the effect of management earnings forecasts bias and accuracy on the underpricing of IPOs. Design/methodology/approach – A sample of 190 Malaysian IPOs listing on the main market of Bursa Malaysia from January 1, 2002 to February 29, 2012 was used and collected data were analyzed through univariate analysis and pooled ordinary least squares regression. Findings – The empirical evidence shows that IPOs underwritten by underwriters as having high market share and charging low underwriting spread experience higher level of underpricing. The paper also finds that IPOs issued more biased earnings forecasts are related with severe underpricing. Finally, this paper reveals that the more accurate the earnings forecasts are, the more minimized will be the asymmetric information and hence, the less will be IPO underpricing. Practical implications – The paper has some implications for policy makers, investors and underwriters. First, this study offers some insights for policy makers who are responsible for Malaysian financial markets current reforms. Further, knowing the importance of the economic outcomes of the earnings forecasts on underpricing for policy makers, they may adopt the findings in their discussion of costs of litigation and potential modifications in the requirements of issuing earnings forecasts. For the investors, findings may improve their understanding of equity valuation and for the underwriters, it would assist them in identifying underwriting cost. Originality/value – This paper is considered the first study to extend IPO literature by investigating the relationships between underwriter’s market share, underwriter’s spread, earnings forecasts bias, earnings forecasts accuracy and IPO underpricing in an emerging country, such as Malaysia.

The Effects of Executive Compensation and Outside Monitoring on Firmss Pre-Repurchase Disclosure Behavior and Post-Repurchase Performance

Using a sample of management forecasts, we find that higher CEO and CFO equity compensation and lower institutional ownership concentration, percentage of independent director, and number of analyst following induce managers to release significantly more bad news, downward biased management earnings forecasts, and withhold good news before share repurchases. These manipulating firms experience positive post-repurchase long-term abnormal stock returns, but have no operating performance improvement. In contrast, lower executive equity compensation and higher intensity of outside monitoring constrain the pre-repurchase management opportunism. These non-manipulating firms do not have post-repurchase long-run stock anomaly, but experience superior operating performances. Our findings show that the corporate governance mechanism has a significant impact of on pre-repurchase managers' opportunistic behavior and post-repurchase stock prices and operating performances.

Experienced Financial Managers' Views of the Relationships among Self-Serving Attribution Bias, Overconfidence, and the Issuance of Management Forecasts: A Replication

ABSTRACTUsing the same questions as Libby and Rennekamp (2015), we survey 110 experienced managers to examine their beliefs about the relationship between self-serving attribution bias, overconfidence, and management's issuance of earnings forecasts. As in Libby and Rennekamp (2015), we find that participants agree that, in general, managers are overconfident. They also agree that other managers likely overestimate the extent to which they contribute to positive firm performance, and that both optimism about the firm's future performance, as well as managers' confidence in their ability to predict future performance, increase the likelihood that earnings forecasts are provided. Finally, participants agree that providing earnings forecasts amplifies the costs of negative outcomes and the benefits of positive outcomes, consistent with the experimental assumption in Libby and Rennekamp (2012). These findings suggest that the experimental findings in Libby and Rennekamp (2012) match experienced managers' beliefs about how real-world earnings forecast decisions are made.

Firm geographic dispersion and financial analysts’ forecasts

Using a text-based measure of geographic dispersion that captures the economic ties between a firm and its geographically distributed economic interests, this study provides evidence that financial analysts issue less accurate, more dispersed and more biased earnings forecasts for geographically dispersed firms. We observe the degree to which a firm has an overlapping distribution of economic centers in comparison to industry competitors and suggest that geographically similar firms have lower information gathering costs and thereby more precise earnings forecasts. Empirical evidence supports this prediction. We further find that the geographic dispersion across the U.S. is less likely to affect forecast precision when a firm has economic activities in states with highly correlated local shocks. Our findings suggest that the effect of geographic dispersion is more pronounced for soft-information environments where information is more difficult to make impersonal by using technological advances. Consistent with the information asymmetry argument, we find that geographically dispersed firms have less comparable and more discretionary managed earnings, have less extensive than industry competitors segment information, are more likely to restate sale segment information, and issue annual and quarterly filings with a delay.

Bias in the post-IPO earnings forecasts of affiliated analysts: Evidence from a Chinese natural experiment

Investment banks and issuers of Chinese domestic IPOs became fully responsible for IPO offer prices only on June 10, 2009. Before this regulatory reform, the optimistic bias in post-IPO earnings forecasts is highly comparable across affiliated and unaffiliated analysts. Afterward, the forecasts of affiliated analysts are 33 percentage points more positively distorted on average. In the first 90 days after an IPO, this relative forecast bias even increases to 63 percentage points and enlarges further when the issuer׳s stock price drops in the aftermarket. Affiliated analysts distort especially their forecasts for fiscal years further away from the forecast release date.

The Impact of Economic Freedom on Analystss Forecasts Bias and Accuracy in Asian-Pacific Markets

This paper studies the impact of economic freedom on analysts’ earnings forecast bias and accuracy by providing empirical evidence from 13 Asian-Pacific countries. Based on data from 2,759 firms over 10 years from January 2000 to December 2009, we find that overall economic freedom has positive impacts on analysts’ earnings forecast accuracy, implying that the higher (lower) the economic freedom, the lower (higher) the information asymmetry, the more accurate the analysts’ earnings forecasts. This study also finds analysts on average are over-optimistic, in particular for less economic freedom countries. We argue that the increase of economic freedom in a country should lessen the information asymmetric problems, and further reduce analysts’ earnings forecast bias.

New Chief Executive Officers Earnings Forecasts Bias At Their First Year Term And Role Of Financial Analysts: Korean Evidence

This study investigates newly appointed Chief Executive Officers (CEOs) earnings forecasts bias at their first year term using listed firm data in Korea. Prior literature reports that new CEOs prefer to report low earnings (big bath or cookie jar accounting) at their first year term for the purpose of income smoothing. However, it is hard to find the studies about new CEOs earnings forecasts bias at the term of low earnings reporting incentive. We question what earnings forecasts bias they usually have when they are interested in low earnings reporting.From the empirical tests, we find that newly appointed CEOs tend to provide conservative (negative) forecasts instead of optimistic (positive) forecasts at their first term. Furthermore, we find that greater analyst following helps to relieve the negatively biased earnings forecasts of new CEOs.This study will contribute to academics and disclosure-related practitioners by documenting about newly appointed CEOs earnings forecasts bias. We also believe that our empirical evidence will be helpful to market participants when they make a business decisions in case of CEO turnover.

The role of accounting conservatism in management earnings forecast bias

Managers are in charge of the financial reporting process, they likely possess superior information regarding the firm’s operations and reporting policies.As such, we expect that managers have a better understanding than other market participants of the implications of the firm’s accounting conservatism for future earnings and, therefore, at least partially adjust their forecasts for the effect of conservatism. The present study investigate whether management earnings forecasts fully consider implications of accounting conservatism on actual earning. We also investigate forecast difficulty due greater earnings volatility and longer operating cycles as one of the possible reasons for managers’ failure to incorporate conservatism fully in their earnings forecasts. Our final sample consists of 86 companies listed in TES for fiscal years 2008-2012. Results also show negative association between conservatism and management forecast errors is stronger for firms with longer operating cycles, greater earnings volatility.

The role of financial analysts in stock market efficiency with respect to annual earnings and its cash and accrual components

AbstractThis study examines biases in stock prices and financial analysts' earnings forecasts. These biases take the form of systematic overweighting or underweighting of the persistence characteristics of cash versus accrual earnings components. Our evidence suggests that stock prices tend to overweight and financial analysts tend to underweight these persistence characteristics. Furthermore, we find that analysts' underweighting attenuates stock price overweighting. However, we find little evidence that the overweighting in stock prices attenuates analyst underweighting. This study brings a new perspective to the literature regarding the disciplining role of financial analysts in capital markets.

A Behavioral Shift in Earnings Response After Regulation FD

The Regulation Fair Disclosure of 1999 (FD) intends to promote the full and fair disclosure of price information and further prevent insider trading. As a result, the public investors are expected to be empowered with more quality and relevant information. This study examines a behavioral shift in investor reaction to quarterly earnings announcements after the passage of the FD due to the expected improvement in information asymmetry. The empirical findings suggest that investors show a behavioral shift after the FD in response to biased earnings forecasts. Investors become more active in that they place a discount on optimistic earnings forecasts during the earnings announcement period. It is less obvious that they place a premium on pessimistic forecasts. Another coherent finding is that investors attempt to correct for the announcement-period mis-adjustments during the post-announcement period.

Impact of audit quality and ownership structure on the bias and accuracy of earnings forecasts issued in IPO prospectuses

Purpose – The purpose of this paper is to investigate the impact of audit quality and ownership structure on the degrees of accuracy and bias in earnings forecasts issued in initial public offering (IPO) prospectuses in a frontier market, Bangladesh. Design/methodology/approach – The paper uses both univariate and multivariate tests on the sample of 75 IPOs. The paper employs the tests to see the association between the degree of forecast bias and three corporate governance variables. Findings – The results reveal that the magnitude of earnings forecast bias is significantly explained by issuer, auditor reputation, proportions of capital raised from domestic as well as foreign investors, and whether the IPO firm is a start-up venture. Underwriter prestige, length of the issuing firms' operating history, leverage, whether the firm went public during a stock market boom, and forecast horizon do not appear to be statistically significant in explaining the degree of forecast bias. Originality/value – Although auditor reputation and the proportion of equity retained by pre-IPO owners have been investigated in several studies on IPO forecast accuracy and/or bias, no study has attributed them to corporate governance as a whole by combining auditor reputation, and ownership categories held by small private investors and foreign portfolio investors.

A New Look at Value Line Earnings and Stock Price Forecasts

This research investigates Value Line short-horizon and long-horizon earnings and stock price forecasts. From 1987-1998, Value Line analysts issued optimistic quarterly and annual EPS forecasts. This is consistent with prior research showing that analysts generally issued upwardly biased earnings forecasts. From 1999-2008, however, the optimistic bias in Value Line forecasts disappeared. Value Line’s long-horizon earnings forecasts were too optimistic, while its long-horizon target price forecasts were slightly conservative. Like analysts generally, Value Line analysts were systematically optimistic with respect to prior-quarter change in earnings, and they systematically underreacted to negative prior-quarter earnings surprises. From 1999-2008, Value Line analysts optimally incorporated information from prior forecast errors for all but the bottom 25% of firms in terms of quarterly earnings surprise. Value Line forecasts appear to hold unique potential for use in equity valuation models, allowing researchers to avoid the distorting assumptions typically required in prior approaches to valuation modeling. The source of the impressive performance of Value Line’s Timeliness rank appears to stem from bias in analysts’ forecasts. Value Line analysts were consistently more conservative (less aggressive) in their forecasts for rank 1 stocks than in their forecasts for rank 5 stocks.

Management Forecasts in Japan: Do Managers Accurately Estimate Costs When They Issue Management Forecasts?

Virtually all firms listed on Japanese stock exchanges report point forecasts of sales and earnings in their annual press releases. The availability of management forecasts in Japan provides a unique research opportunity to investigate managers’ prediction of cost behavior of their company. Forecasted costs are available by subtracting forecasted earnings from forecasted sales. Using recent “sticky cost” research methods, the forecasted rate of change in costs can be compared with the actual rate of change in costs. Specifically, I describe the forecasted rate of change in costs as a function of the forecasted rate of change in sales, and comparing the forecasted rate of change in costs with the actual rate of change in costs. The rationale for this approach is, in theory, that costs are resources sacrificed to generate sales; hence, it is generally expected that costs increase (decrease) as sales increase (decrease). Basically, focusing on the relationship between forecasted sales and costs provide deeper insights into management earnings forecasts than focusing on the forecasted earnings because earnings are the aggregated measure of sales and costs. The major findings of this paper are that managers underestimate the rate of increase in costs when sales are expected to increase; however, they tend to overestimate the rate of decrease in costs when sales are expected to decrease, indicating that costs are underestimated regardless of the forecasted direction of change in sales. These findings imply that optimistic bias in management earnings forecasts can partly be attributed to the forecast error of rate of change in costs.

Is There a Limit to the Accuracy of Equity Valuation Using Multiples?

We investigate the reasons for there being an apparent limit to the accuracy of valuation using multiples, when it is implemented in a standard way. We find that most of the error comes from failing to correct known biases in earnings forecasts. Another part comes from mismatching observable characteristics of target firms but the only characteristic that matters is growth. A smaller part comes from mismatching unobservable but persistent characteristics of the target firm. We develop a procedure to eliminate these errors, which reduces the variance of valuation errors by more than 60%. The remaining error is mainly random noise.