The Effect of Earnings Quality on Analyst Forecast Optimism

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Abstract

This study examines the relationship between that the quality of reported earnings and analyst earnings forecast optimism. Prior literature reports several determinants of forecast optimism including the type of firm for which the analyst works, the analyst’s experience, the number of firms followed, and the total level of accruals. To operationalize earnings quality we use two methods described in the literature. Following prior research the first method assesses quality by the timely mapping of accruals to cash flows. The second identifies accruals as either discretionary or non-discretionary, with lower discretionary accruals indicating higher quality earnings. Because earnings management is often performed to increase reported earnings, and because optimistic forecasts are errors of overestimation, it is reasonable to expect that high earnings quality will result in less task complexity and therefore provide better information on which to base more accurate, less optimistic predictions. Following prior literature we control for prior period losses, changes in earnings from the prior period, forecast horizon, the number of forecasts issued by the analyst, and the dispersion of analysts’ forecasts. The expectation of this study is that higher levels of earnings quality are associated with decreased forecast optimism.

Authors

• David Salerno, University of Scranton

• Nathan Hans Jeppson, Montana State University - Bozeman