The Relation between Market Reactions to Management Earnings Forecasts and Meeting or Beating Analyst Forecast Benchmarks

• In Event: Financial Accounting and Reporting 1

Abstract

Graham et al. (2005) report that managers believe financial performance impacts the credibility of their forecasts. This belief is also echoed in the business press. We investigate the validity of this belief by testing whether management earnings forecasts (MEFs) issued by firms that meet/beat the analyst forecast (AF) benchmark appear to have greater credibility than MEFs from firms that miss this benchmark. Using a sample of small firms, we find that the information contained in MEFs is more highly associated with current period cumulative abnormal returns for firms that meet/beat the AF benchmark than for firms that miss the benchmark. Our analysis also indicates that this increased association is not a temporary effect, but instead persists over an extended time horizon. We further investigate whether managers use this increased credibility to manipulate earnings expectations or to aid investors by issuing accurate earnings guidance. We find evidence that, on average, managers use the increased credibility of meeting/beating AF benchmarks to accurately convey guidance rather than to act opportunistically.

Authors

• Kenneth C Rakow, Loyola University - Chicago

• Samuel Louis Tiras, Indiana University - Indianapolis

• George Wilson, Northern Michigan University