Heterogeneous Beliefs, Speculation of Investors and Management Forecast

• In Event: Capital Markets Research IV

Abstract

This paper investigates how managers alter their financial forecasts in response to speculative activity driven by heterogeneous beliefs (disagreement) among investors. Managers may take actions to either maintain the resulting speculative premium or reduce the speculative risk. We adopt Kelly and Pruitt (2015)’s three pass regression filter to measure speculative trading driven by heterogeneous beliefs, and establish causality using the exogenous variation in speculative trading after the yearly reconstitution of the Russell 1000 and Russell 2000 indexes. When short sale constraints are binding, managers respond to speculative trading by issuing fewer earnings and sales forecasts and issuing less precise and longer horizon earnings forecasts. In contrast, when short sale constraints are not binding, managers respond to speculative trading by issuing more earnings and sales forecasts and issuing more precise and shorter horizon earnings forecasts. The above results are stronger when managers have stronger equity incentives. We also find that managers trade to take advantage of the resulting price and are more likely to cater to optimism of investors in response to great speculative premium.

Authors

• zhiwei Xu, Rutgers Business School-Newark and New Brunswick

• Valentin Dimitrov, Rutgers Business School-Newark and New Brunswick